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What Is A 529 Plan And What You Need To Know About It

With the costs of a higher education continuing to rise, one college financial planning strategy many families use to invest in is a 529 plan. Authorized by Section 529 of the Internal Revenue Code, 529 plans are legally known as “qualified tuition plans,” and are “sponsored by states, state agencies or educational institutions.”

529 plans offer tax-advantage savings, such as tax-deferred growth and tax-free withdrawals for qualified expenses, and are designed to encourage parents to save for educational expenses.

There are several pros and cons to investing in a 529 plan, however. Whether you have a 529 plan already in place or are considering opening one for your child, here are the pros and cons you need to know, plus seven strategies to make the most of saving for college.

Pros of a 529 plan include:

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1. High Contributions. 529 plans let you make a higher annual contribution than other traditional college savings plans. A parent can contribute up to $15,000 per child per year or make a single $75,000 lump-sum contribution (a one-time 5-year contribution) without triggering gift tax reporting or reducing your lifetime gift exemption. If you are married, your spouse can do the same.

2. Tax Advantages. A 529 plan provides federal tax-deferred savings and tax-distributions as long as it covers qualified expenses like tuition, books, supplies, etc. Some states (but not all) offer tax incentives to investors as well. We recommend 529 plans ONLY for families with high income and high tax liability who will benefit from these tax advantages .

3. Flexibility. 529 plans do not have age or income restrictions and can pay for certain expenses at both public and private colleges as well as apprenticeship programs registered and certified with the Secretary of Labor. Unused 529 plan funds can be saved for future education, such as a professional program or a graduate school, or even rolled over into an account for another beneficiary, such as a grandchild.

Cons of a 529 plan include:

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1. Limited Options. 529 plans generally only offer mutual funds rather than stocks or bonds, and you can’t transfer stocks and bonds into a 529 plan without liquidating them.

2. Potential Penalties. If you use the funds for expenses that are not related to education, you will likely need to pay income tax and a withdrawal penalty on the funds you use.

3. Market Risk. 529 plan funds are invested in the stock market and subject to market volatility. There is no guarantee that your funds won’t lose value.

4. Impact on Financial Aid Qualification. A 529 account owned by a parent for a dependent student is reported on the Free Application for Federal Student Aid (FAFSA) as a parental asset. Parental assets are assessed at a 5.64% rate in determining the student’s Expected Family Contribution (EFC).

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Seven Savvy 529 Plan Strategies

  1. The 529 should not be the first place to save for college for most families! I recommend that ALL families who qualify (married with income less than $206,000 or single with income less than $139,000) should contribute the maximum to their individual ROTH before putting any money into a 529. Parents can each contribute $6,000 per year ($7,000 if they’re older than 50). The ROTH offers all the PROs of the 529, but none of the CONs!
  2. Many families qualify for more need-based financial aid than they ever thought possible. For example, a family with two students attending $50,000 private colleges and more than $200,000 of income could qualify for financial aid. BEFORE choosing where you will save for college, make sure you know whether need-based financial aid will be in your college planning strategy.
  3. When withdrawing money from a 529 plan, it is important not to withdraw too much or too little. If you take too much money out of your account, you’ll need to report the amount that isn’t used towards qualified higher education expenses as taxable income and pay a 10 percent federal penalty tax on it. But you don’t want to have money left over in your 529 account after your child graduates, either.
  4. The funds you take from your 529 plan need to match up with the same calendar year you pay for the qualifying expenses (like tuition). Be sure to save any receipts, just in case an expenditure comes into question.
  5. The federal government now allows monies from a 529 plan to be paid toward qualified student loans. The limit is $10,000 per child and any portion paid with 529 monies does not qualify for the student loan interest deduction. Before making any loan payments from your 529 plan, check the rules for your state with your accountant. Not all states are aligning with this federal change.  
  6. Research school policies before requesting payment be made directly to them. Some schools factor 529 money into their financial aid process, so if the funds go directly to them it might impact the amount your student receives in federal and school-based grants, and could even be misconstrued as scholarship monies. As a rule, I recommend requesting that 529 funds be distributed to the parents, who then pay the college bill from their personal account.
  7. Some children are the beneficiary of multiple 529 accounts with different owners like parents, grandparents, etc. Make sure you talk to other family members well in advance of when you need the money to use the various 529 accounts in the best way possible. For financial aid optimization, non-parent owned 529 funds should be used to pay for the later college years.

Need Help Navigating Your College Funding Plan?         

Do you want to know more about establishing a college funding plan and whether to use a 529 plan to help pay for college? At Westface College Planning, we can help! Contact us today with your questions!              

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