What's a 529 Plan?

A 529 Plan is a way to save money for post-secondary or higher education that can used at schools across the country, and outside the US. The name “529” refers to section 529 of the Internal Revenue Code (Internal Revenue Code, 26 U.S.C. § 529) that allows the establishment of this type of college saving investment vehicle. 529 plans were created by Congress in 1996 based upon the structure of 401(k) retirement plans.All 50 states and the District of Columbia sponsor at least one type of 529 plan.

Soaring tuition and confusing college savings options can make planning for your child's education seem overwhelming. We can help you take the guesswork out of choosing the right investment or savings vehicle.

They are designed to help parents and grandparents begin saving for a child’s college educational expenses by providing investment options that allow them to withdraw funds for qualified educational expenses, tax free.

With the many attractive features and benefits they offer, 529 plans have become one of the most popular ways to save for college. A 529 plan gives you the benefits of tax-advantaged investing, control, and flexibility. And most importantly a 529 plan can give you the peace of mind that you are saving to help the child in your life have a more successful, brighter future.

Here are some of the benefits of a 529 plan:

• Tax-deferred investment growth and withdrawals that are free from federal and state taxes when used for qualified higher education expenses¹

• Professional investment management

• Control over how assets are used

• Gift and estate tax benefits

• Qualified expenses that include tuition, some fees, books, and certain room and board

• Protection from bankruptcy

• Ability to use funds at almost any college in the U.S. as well as hundreds of other institutions abroad

The investment strategies, tax benefits, and incentives offered by 529 plans vary by state so it is important to consider the advantages of your own state as well as others. While most plans allow investors from out of state, there can be significant state tax advantages and other benefits, such as matching grant and scholarship opportunities, and exemption from state financial aid calculations for investors who invest in 529 plans in their state of residence. California currently does not offer any incentives, such as a deduction or credit on your state income tax return for contributions you make to an in-state plan, thus it is best to consider all states’ plans before deciding which plan is best for you.

Borrowing for college may not be a good idea

Saving even a little can beat borrowing. While most families combine some level of savings and borrowing when paying for college, putting aside money early and often is a proven way for you to build your savings. Due to the power of compounding, saving and investing even a little each month is usually more cost-effective than borrowing money and paying interest on it. Never save for college at the expense of your retirement though. If the choice is between putting money into a 401(k) plan or a 529 plan, fund the retirement account first. You are going to be retired longer than your child is going to be in college. He or she can borrow for college at advantageous tax-deductible rates, but you should not borrow to fund your own retirement.² 

What impact does a 529 plan have on financial aid?

Participation in a 529 college savings plan does not limit a student's receipt of merit-based financial aid, including academic or athletic scholarships. While a 529 account could potentially impact needs-based aid, remember that most needs-based financial aid that is awarded is actually in the form of loans that must be repaid, not grants. While many parents and grandparents are often concerned about this issue, a 529 plan may help reduce the amount of debt a student has to take on in the form of loans.

A 529 account, owned by a parent for a dependent (the student) is reported on a Federal Student Aid (FAFSA) application as a parental asset, which is assessed at a maximum of 5.64%. Non-529 student assets (such as UGMA/UTMA accounts) are assessed at the higher rate of 20%.

To learn more about the benefits of saving for college, contact us at 415-568-2150 or visit www.gvwealth.com. Become educated on 529 plans so in turn, you can educate your child.

1. Earnings on non-qualified withdrawals are subject to federal income tax and may be subject to a 10% federal penalty tax, as well as state and local income taxes. The availability of tax or other benefits may be contingent on meeting other requirements. 529 Plans are subject to enrollment, maintenance, administration/management fees and expenses. Make sure you understand your state tax laws to get the most from your plan.

2. I know I said you should fund your retirement first, but if you must tap into your IRA, there are some advantages. If you withdraw money from a traditional IRA for college, you do not pay the standard 10% penalty for an early withdrawal, though you still owe income tax on the amount withdrawn. If you withdraw money from a Roth IRA, there is no 10% early withdrawal penalty and income tax applies only to interest earned, not to the original amount contributed. (note that if you only withdraw your contributions, there are no taxes at all.) The money withdrawn can go towards the usual tuition and fees, and also toward books, supplies, and if your students is attending college at least half-time, you can even apply withdrawals toward room and board. Consult a tax professional for further details.

This is article is part of an educational series to assist investors in making better decisions, either on their own or through the investment counseling services of Green Valley Wealth Advisors. Our aim is to have informed investors create a community for sustainable wealth and success. For more information on 529 plans, click here.

Green Valley Wealth Advisors | April 11, 2010

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