I wanted to take a short break from the series of blogs I’ve been writing to talk about the ever-growing, ever-looming issue of college tuition. For the time being, I only have to worry about sports fees and music music lessons but I know that in the blink of an eye I’m going to have two children in college at the same time. I don’t like thinking about what the cost of college will be ten years from now and I especially don’t like thinking of the cost of college for two kids at once.
There are countless ways to save for your children’s education, but one of the best is the 529 Plan. Officially, section 529 of the Internal Revenue code, is known as “Qualified tuition program” and has been around since 1996. This program is divided into two basic types of plans, a prepaid tuition plan and a savings plan. The 529 Plan is exclusively for postsecondary education such as college, university, or vocational schools as long as that institution is eligible to participate in a student aid program administered by the U.S. Department of Education. 529 funds are used to cover expenses such as: tuition, education related fees, books, room and board and has been recently updated to include computer technology and equipment and internet service. Funds must be used only for expenses related to qualified education.
Funds contributed to a 529 plan are not tax deductible. However, the money contributed can grow tax free and is not taxed when funds are used for a student’s education. The tax savings can be significant depending on how soon you are able to start contributing and how much you are able to contribute overall. Funds in a 529 plan are not subject to federal or state tax, income tax, capital gains taxes or Medicare surtax. Additionally, distributions are not reported as income to the beneficiary regardless of the owner-beneficiary relationship. There is also no limit to the number of plans you can set up.
The 529 plan has benefits beyond the direct expenses of postsecondary education. Federal financial aid formulas are calculated based on parental and student assets. The money in a 529 Plan is classified as parental assets and considered at the maximum amount of 5.6%. Essentially, if you have a 529 plan for your child, only 5.6% of the total is taken into consideration as an asset and therefore the potential financial aid amount is higher. On the other hand, other types of savings plans consider the funds as assets for the student and as much as 20% of the funds can be considered in the financial aid process.
The flexibility of a 529 plan exceeds that of other college saving plans. Anyone can set up a 529 Plan for any student, even themselves. The beneficiary can be changed with no penalty, or funds can be rolled over into another 529 plan. Both options are essential for families with potentially more than one student seeking higher education. There is no income or age restriction and contribution amounts are not restricted as they are in other plans. In addition, you are not restricted into using your state’s 529 plan; you have the option to pick and choose from any state. There is however, a cap of $300,000 so no additional contributions can be added once that cap is met. Even the investments can be changed twice per calendar year or when the beneficiary is changed. Withdrawal of 529 plan funds for use other than education expense would be taxed as income and the owner will also receive a 10% penalty on the amount withdrawn. Beneficiaries that receive full college scholarships will generally still have a variety of fees to pay for, but in the case of a scholarship situation, the 10 percent penalty is waived. Each college savings plan has benefits that may fit your needs more than others. Discuss the options with your financial advisor to find the plan that works best for you.