This year, total student loan debt has climbed over the $1 trillion mark and tuition continues to grow at double the rate of inflation. Starting a college savings plan has never been more important. The earlier families get started, the better.
Most of the time, families are well-intentioned and want to save for their children's education. However, with the large variety of vehicles that a family can use to save for college, it can be difficult to sort through all of the rules.
The plethora of plans and options can cause confusion and lead to families taking the path of least resistance and just saving money for college in a savings or money market account. If the child is young and not going to college anytime soon, a savings account is probably not the best tool to use since rates on savings accounts are extremely low and the cost of college tuition grows every year at a rate much quicker than inflation.
Using the 529 Plan as a College Savings Vehicle and Overall Financial Planning Tool
A previous post here at Epilawg, highlights the basic details of 529 plans. The objective of this post is to take it one step further and provide a useful guide to put a plan into action.
While 529 Plans have been around for a while. A report from the Financial Research Corporation showed that just 27% of all the money Americans saved to pay for college grows in 529 plans (data from 4th Qtr 2011). That number is expected to grow but it does bring up the question about why more investors aren't using 529 plans.
529 plans certainly aren't perfect, but they offer a host of benefits that other college savings vehicles don't offer. With 529 plans the devil is in the details because each plan will have its own set of rules and benefits.
Here are eight advantages of 529 Plans to consider:
1. Tax-free growth and tax-free withdrawals for approved higher educational expenses. The cool thing about 529 plans is that they are pretty flexible on what's considered an approved higher education expense. Rest assured that things such as tuition, books, campus housing costs and equipment such as computers can be paid for with money from a 529 plan.
2, Many states offer a state income tax deduction for in-state residents. Before selecting a 529 plan, make sure to look at the in-state option to see whether a state income tax deduction is offered.
3. An investor can use any state's 529 Plan. Some families get confused and think that they can only save into their resident state's 529 Plan. That's not the case. An investor can use any 529 plan from any state. The first thing to consider is whether a state income tax deduction exists for in-state residents. It would be a shame to miss out on a deduction because of missing some fine print. If there isn't a tax deduction available for residents then feel free to investigate plans based on investment options, past performance, management and costs.
4. A 529 Plan can be pre-funded. As explained in the Epilawg post on 529 Plans, a couple can fund a 529 Plan up to five years in advance, tax-free. This provision can become a powerful estate planning tool for families with a large amount of assets. The current federal gift-tax exclusion is $13,000 per individual for any given year. This means that in a given year a couple could contribute up to $130,000 into a 529 Plan ($13Kx2X5).
This applies to an unlimited amount of beneficiaries. A person could set up as many accounts for different beneficiaries as they desire. For example, if grandparents wanted to give their three grandchildren funds for college, they could set up three separate 529 plans, one for each grandchild. With the current federal gift-tax exclusion of $13,000 per individual and the pre-funding option available only with 529 plans, the grandparents could transfer up to $390,000 out of their estate. That’s a maximum amount in this scenario. However, the power of this planning concept should be apparent.
The key is to understand that any amount invested in a 529 plan does not count as part of a person's taxable estate. If grandparents wanted to find a way to gift assets to their grandchildren and lower the value of their taxable estate, then the 529 Plan could prove to be a great tool.
5. Keep control of the money. This is usually a big one for parents and grandparents when considering a savings vehicle for college. People want to know that if they change their minds, they have a way to get their money out. It’s important to know that the owner of the account, usually a parent or grandparent, is always in control of the assets and withdrawals of a 529 plan.
Not only does the owner retain control of the account, but the money in a 529 plan can always be taken out by the account owner. The only downside is that if there is any growth in the account the owner would pay income tax on the growth, plus a 10% penalty if the money wasn’t used for higher educational expenses. The owner could always change the beneficiary on the 529 plan instead of taking the money out and incurring taxes and penalties. A beneficiary can be changed to another relative, child or grandchild. They could even use the 529 plan for themselves.
6. The 529 plan makes a great legacy tool. Because the beneficiaries can be changed very easily on a 529 plan, it can be reassigned to the next generation.
7. Shelter against bankruptcy and creditors. This could be a potential benefit for people who are in high risk entrepreneurial professions or business owners.
8. It plays nice with other strategies and investment vehicles. It's not required that all college savings go into a 529 plan. Some families may choose to keep some investments in other types of accounts for flexibility and liquidity. Most likely those other accounts will not provide all the benefits of a 529 plan but there could still be a reason for maintaining some college savings in other vehicles.
What to look for in a 529 plan.
There is a great website about 529 plans. The website is packed with useful information about 529 plans and it also provides informative college savings tips. It would be a good place to start when researching 529 plans.
The first thing to consider is whether the in-state plan offers a state tax deduction. If it does, then all things the same, it would make more sense to use the in-state plan.
Secondly, take a look at the investment options in the plan. Does it provide a wide variety of low-cost mutual funds? The best plans will provide individual mutual funds as well as age-based portfolios. Age-based portfolios are a type of “set it and forget it” investment option that is available in most 529 plans. It allows the plan owner to select a mix of investments based on the current age of the child. The portfolio will automatically adjust to a more conservative allocation as the child ages and gets closer to needing the money for college expenses.
When looking at all the investment options consider the strength of the investment company that offers the plan. Do they have a good track record? Do they have good investment managers? There is a comparison tool that can provide some good insights.
And finally, take a look at the fees associated with the plan. For some reason, some plans are more expensive than others. Gauging value against price is important. Is there a reason for the difference in costs? Again, the Saving for College website will show the costs and fees associated with any 529 plan.
Then choose a plan and open it up. Most of these companies have good customer service departments and want to make it as easy as possible to open a new account. Most 529 plans don't require a minimum investment if you set up an automatic investment plan. Usually an automatic investment plan can be set up for as little as $25-$50 a month.
Final word about 529 plans.
Make saving for college a family affair. With a 529 plan anyone can make a contribution to the plan. Grandparents, aunts, uncles or even great grandparents can contribute to the plan.
There is something special about the peace of mind that comes with having a dedicated college savings fund set in place. Studies have shown that children of families that have saved for college are more likely to actually go to college than those whose parents didn't save anything. With the competitive career market a college education is an extremely valuable asset.
There's no need to be confused about any of this. A good idea is to speak with a professional financial consultant about saving for college and even retirement. These are two of the biggest financial goals in a person's life and they need to be planned for.
Remember, choosing not to do anything is still a plan. The earlier the habit of saving into a college savings plan is set the more benefit it will provide in the future.
Neither Woodbury Financial Services, Inc. nor its representatives offer tax or legal advice. For assistance with these matters, please consult your tax or legal advisor. While this information has been checked with sources believed to be reliable, the accuracy cannot be guaranteed. This information is intended for general education only, and investors should carefully consider their personal situation and circumstances. Securities and Investment Advisory Services offered through Woodbury Financial Services, Inc. Member FINRA, SIPC and Registered Investment Adviser. PO Box 64284 St. Paul, MN 55164 (800)800-2638.