Time to Renew the Spotlight on 529 Plans
With the average cost of a year at public universities exceeding $25,000, students and parents alike struggle with how to pay for an education. Student loans are one answer – but the average student loan debt for 2016 graduate is a stifling $37,712. Maybe a better – though often overlooked – way is through 529 plans.
So what are 529 plans? The IRS explains that a 529 Savings Plan is a savings plan operated by an educational or state institution. The legal name of the plan is the Qualified Tuition Program. Many states offer investors incentives to enroll in a college savings plan on this date, but the benefits of these plans on their own can’t be overstated.
Anyone can set up one of these plans without any income restrictions on the contributor or beneficiary. There are also no limits placed on the number of plans that an individual can set up. The beneficiary can be a child, grandchild, other relative, friend, or even yourself.
Why worry about it now? Because May 29 is National 529 College Savings Plan Day.
Types of 529 Savings Plans
There are two primary types of plans: savings plans and prepaid tuition plans. Contributions for either type cannot exceed $14,000 within a given year without potential tax consequences for the beneficiary.
It is important to note that contributions to 529 plans do not allow the contributor to count them toward their federal income tax deductions. However, money invested in 529 plans will continue to grow over time and will not be taxed when it is withdrawn and used to pay for qualified education expenses.
People who live in areas that have state income taxes may be eligible for deductions on those taxes. This typically only applies to those plans that are offered by in-state institutions or schools and that should be factored in when considering which plan to go with.
Funding the future
Parents, or others interested in contributing to a 529 plan, may be concerned about the financial risk associated with this type of investment. Concerns could include the beneficiary deciding they are no longer interested in attending an institution of higher education or that they will use the money for something other than tuition and related fees.
A 529 plan allows the donor to remain completely in control of the funds. With very few exceptions, the person named as the beneficiary has no intrinsic legal right to the funds. The money is not transferred to the beneficiary at a certain age. This allows the contributor to maintain control over the funds and ensure they are spent in the intended manner.
It is also possible for the person who sets up the plan to change the beneficiary at any time. If one person will not be able to use the funds or has no desire to further their education, a new beneficiary can be selected. This helps ensure the money is not trapped in an account and unavailable if the future does not play out as expected.
Another concern for many investors is that they will not be able to withdraw the money if their own circumstances should change for any reason. Funds that have been placed into the account can be withdrawn by the contributor at any time and for any reason without a federal tax penalty because the money was taxed prior to being invested.
However, if the interest earned on the money is withdrawn for a non-qualified reason it will be subject to all applicable income taxes as well as an additional 10 percent penalty. This means all the original money invested can be removed without any negative consequences by the owner.
Most people decide to go with a 529 plan offered by a provider within their own state but this is not necessary. One of the most significant benefits of investing in a 529 plan is the sheer number of options available. When looking at plans it is advisable to think outside the state, especially for those who live in areas without state income taxes and would not benefit from any additional tax deductions.
According to Kristen Moon, an independent college counselor and founder of Moon Prep, another benefit is the ease with which one can set up a 529 plan. She says, “Account owners can set up automatic investments so they don’t have to worry about managing the account month-to-month.”
She also points out that owners can choose the level of investment risk they are comfortable with and the fund managers will find an appropriate match.