Anna Wright
529Growth
Everyoneknows acollege education is getting more expensive each year. To give families another tool to help save for higher education, U.S. Congress created Section 529 of the Internal Revenue Code in 1996. Legally known as “qualified tuition plans,” 529 savings plans offer a tax-free way to put money aside and let it grow for future education expenses.
“What’s better than growth?” asks Jerome Rieke, an Edward Jones financial adviser in Akron and an Accredited Asset Management Specialist. “Tax-free growth. It’s one of the biggest things the financial services industry has come up with to enable people to achieve college financial goals.”
Rieke walks us through the benefits and downsides of 529 savings plans, as well as important changes to the plan that open the door to using them to save for elementary, middle and high school education.
What Is a 529 Qualified Tuition Plan?
“A 529 plan is a state-run plan that allows an investor to save money on a tax-advantage basis and withdraw from the account tax free for qualified educational expenses,” Rieke says. In other words, both the money you contribute to a 529 plan and any interest it earns will not be taxed by the federal government when you withdraw it for use toward qualifying educational expenses, which include things like tuition, mandatory fees, and room and board.
To qualify for the tax break, though, the funds must be used at an accredited institution. “When we say accredited, we usually mean that the institution is able to accept [federal] financial aid,” Rieke says. That means not only most four-year universities but also many trade schools, culinary schools and some non-U.S. colleges may qualify, but there are other stipulations, as well, most of which vary by state.
Though individuals may certainly set up a 529 account on their own, Rieke makes a strong case for consulting a financial adviser to make the most of it. “A 529 plan is a very important asset, just like any other part of their financial plan,” he says. “One of the things that investors may struggle with is trying to figure out how much of their money they should put toward college planning.”
Because growing a 529 account to the point where it can really make a dent in education expenses takes time, a family needs to decide what portion of their income they can allot to it versus other savings vehicles, like retirement accounts, and a financial planner can help with that.
Another reason to seek professional guidance is the fact that these are investment accounts, meaning the money in them is subject to the ups and downs of the stock market, as well as the expertise of whoever is managing them. “Any investor’s usually going to be well served by doing some due diligence on the investments that a particular 529 plan is going to offer and monitoring those assets during periods of turbulence,” Rieke says.
The simplest part of a 529 is that the beneficiary does not need to be related to you — you can create one for anyone you want to help with an education, including yourself.
Anna Wright
529Growth
What’s Changed Recently?
The big news is that the Tax Cuts and Jobs Act of 2017 opened these plans to use for tuition at any elementary, middle or high school as defined by relevant state rules, including public, private and parochial schools. Previously, 529 plans were dedicated to saving for college only.
This is great for parents of younger kids, especially, but Rieke has a few words of caution. “Now that they’re able to use the money the same year they put the money in or the next year, their time frames for investing the money need to be taken into consideration as well.”
Traditionally, families would invest in a 529 plan from the time a child was in first or second grade with an eye on college down the road, giving the funds plenty of time to grow. If, however, you now want your sixth-grader to go to a private high school, you may have to rethink how much you can contribute to the account and whether it will yield sufficient growth to get you there. The longer the funds have to accumulate growth, the more money you’ll have available when tuition time comes up.
It’s also important to keep in mind that there is a maximum withdrawal of $10,000 per year per beneficiary for K-12 expenses. But for college expenses, there is no limit to the yearly amount you can withdraw.
How Do the Plans Work?
Like most things tax-related, there are both state and federal implications for 529 plans. “The federal government will almost never tax the 529 plan monies, which is terrific because federal tax, pretty much for everyone, is the higher number,” Rieke says. “But for state taxes, it starts to get more complicated.”
Each state creates its own 529 plan with its own money manager who is responsible for the investments of that fund. The states also set their own contribution caps, fees and other restrictions. Income level is not a factor in who can start a 529 plan, and investors are not required to use their home state’s plan — or even the plan for the state where the beneficiary will attend school. Rieke says choosing the right plan depends on a lot of things, including your personal time frame and ultimate goal for your 529.
“There may be more money, more growth to be had using a different state’s 529 plan if you feel that the money managers of that other state’s plan will more capably help you achieve your financial goals,” he says.
Many states offer tax incentives for in-state residents to invest in their plans while others offer no incentive at all.
“In Ohio, for example, a person making a contribution into a 529 plan can deduct up to $4,000 per year per beneficiary when filing their state income tax,” Rieke says. “Other states, instead of offering a deduction, offer a tax credit. So an investor would really want to do a bit of research before deciding which state’s 529 they want. The potential growth may outweigh the state tax deduction.”
What are the Downsides?
One of the few downsides to a 529 plan is the eventuality where the beneficiary decides not to go to college — every parent’s nightmare. But it’s not the end of potential savings.
“You have a couple of options. One is you could simply put a different beneficiary on [it],” Rieke says. Although you can start a 529 for anyone — related to you or not — if you’re changing the beneficiary, the new beneficiary must be a relative, or else there may be adverse tax consequences.
The absolute worst-case scenario is you withdraw the funds for noneducational purposes and pay regular income taxes on them plus a 10 percent Internal Revenue Service penalty.
What Are Its Advantages?
“The biggest advantage, and it’s a powerful one, is the tax advantage,” Rieke says. “To put it simply, if you take a dollar and allow it to grow tax deferred — meaning you’re not having to give up some of that growth to the IRS — it means that every year you have more and more money earning interest on itself.”
That exponential growth is one of the biggest selling points of any investment account, but Rieke explains how 529 plans offer a second benefit on the back end, when funds are withdrawn.
“You get to take not only your contributions but all that delicious tax-deferred growth out of the account without having to pay taxes on it either,” he says. So long as the funds are being used for an accredited educational institution, the government does not tax them, leaving lots more money in a family’s college-planning pocket.
Another advantage is the person who creates the account always retains control over it. That means your child will not gain access to the funds at age 18 and decide to go buy a car with the money you’ve been putting aside for college all these years. “Parents and grandparents love that,” Rieke says.
What’s the Bottom Line?
The decision to save for education with a 529 plan is as personal — and important — as selecting an alma mater. You’ve got to consider what you want to get out of it, as well as what you will put into it. “This is a big deal,” Rieke says, “not just because it allows 529 owners to use the money in more places during a child’s educational journey, but also in terms of the decision-making account owners now need to make.”
