529 Plans: The What, Why and How by Winnie Sun

This year’s State of the Union speech stirred up discussion about the 529 college savings plans by threatening the tax-free withdrawal for education that makes 529s so popular. Thankfully, Obama has since dropped that piece from his education reform plan.

Since then, many of our clients have been asking: What is the 529 Plan? Why is it different from, or better than, other savings vehicles? How do I set one up? Read on!

According to Bloomberg, the price of college has risen 1,225 percent since the late 1970s. A study by FinAid.org projects tuition increases will double the cost of college every nine years. It is imperative that families save for education. In a recent study by MoneyTips.com, 30 percent of millennials list college debt as a detriment to their financial independence.

What is the 529 Plan?

The 529 college savings plans are tax-deferred accounts where parents can stow away up to $14,000 each year for their child’s education without triggering gift tax or eating into their lifetime estate and gift-tax exemption amount. They can also front-load five years’ worth of contributions to the plans as the Obamas did in 2008, contributing $240,000 in total for their two daughters to the plans.

Unlike a 401(k) retirement plan, families can only save post-tax dollars in a 529 college savings plan. As long as 529 funds are withdrawn for higher education, the investment gains are not federally taxed.

The early model of the 529 plans, conceived back in the 1990s, was similar to Obama’s proposal and not very popular. When Bush signed the Economic Growth and Tax Relief Reconciliation Act into law in 2001, the financial outlook improved for 529 plans. Assets in 529 plans have jumped from 19.4 billion at the end of 2001 to 245 billion in 2014, according to the Investment Company Institute.

Why is the 529 Plan different from, or better than, other savings vehicles?

According to Paul Curley, Director of College Savings Research at Strategic Insight, “Many products are used for savings such as taxable brokerage accounts, 401(k) plans and insurance products, although none are specifically geared toward paying for college like the 529 Plan.

Curley adds that if our government penalized the 529, “the current percentage of parents not saving for college would increase from its current percentage of 25% as reported in the attached graph. Additionally, the percentage of 529 users would decrease from the current percentage of 33% even though they would still gain federal tax deferral and state tax benefits on contributions and gains.”

How to Set Up a 529 Plan

Most states have a 529 plan, and some have more than one. The state picks a single administrator, usually an investment firm like Legg Mason or Fidelity, to manage the plan.

While you don’t have to choose a plan from our own state, doing so might provide a better tax deduction. One option is to purchase your plan directly from a financial adviser like us who will take the time to advise you on your family’s education savings plan. Each state’s fund(s) has different investments, fees, contribution limits and residency requirements.
529s come in two varieties: prepaid plans and investment savings plans.

  • The prepaid plans require payment for tuition ahead of time. Doing so locks in the school’s tuition rates, even if the tuition has gone up by the time your child enrolls. Some prepaid plans cover all higher education costs, while others can only be used for tuition and fees.
  • Savings plans are similar to IRAs or 401k plans in that you choose an investment option and your earnings are dependent upon the performance of the investments.

Although 529 funds allow withdrawals for non-education expenses, the penalties can be steep. In addition to the 10 percent government penalty, you’ll also be required to pay taxes on any gains. These penalties are waived when a child wins a scholarship or in the case of disability or death.

Finally, for families with more than one child, 529 beneficiaries can be changed each year. If there is money left over from one child, it can be used for another. You can even keep the fund open for your grandchildren, or to go back to school yourself. It’s nearly impossible to save too much in a 529 account.

For a complimentary consultation on 529 colllege savings plans, simply reach out to us via www.sungroupwp.com or www.corporate529.com.