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Liberate Your College Savings With A 529 Plan

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Steve Pomeranz, 529 Plan

What Is A 529 Plan?

Today, I plan to talk about 529 plans which, I believe, should be considered for every child.  A 529 plan is a tax advantaged savings plan that encourages you to save for your child’s future college expenses by giving you tax-savings on money that you put into the plan and allows tax-free withdrawals provided that money is used for educational expenses.

There are two types of 529 plans: pre-paid tuition plans that a lot of people are familiar with and college savings plans.  Pre-paid tuition plans generally allow college savers to purchase 2 or 4 years of tuition and/or room and board at participating colleges and universities. They are typically sponsored by state governments and have state residency requirements, so they tend to be pretty restrictive and are not such a good option if you’re open to colleges outside your state.

But today, I plan to focus on the more popular College Savings Plan.

College Savings Plans

In a college savings plan, you—as the account holder—open an account and designate a single beneficiary, just one person that you can give the money to, and it is earmarked for “qualified higher education expenses” only. This includes tuition, room & board, mandatory fees, books, and computers.  These plans have no age limit, are open to adults and children, have no residency requirements, and can be opened anytime with no restricted enrollment periods.

Withdrawals from college savings plans can generally be used at any federally qualified college or university, and I’ve included a link on my website that lets you search for eligible schools by state and city.

The money in this account is your asset; you control it at all times and your beneficiary has no right over this money, so that’s a good safeguard against a wayward son or daughter—if you know what I mean!

Single Designated Beneficiary; Beneficiary Can Be Changed

You can’t open a 529 plan, then distribute funds to multiple family members, even if it’s for qualified college expenses.  Your funds can only go to that one designated beneficiary.

So, if you have two children who are about a year-and-a-half apart in age and will likely overlap in college, you’ll have to open two 529 accounts, one for each of them.  But if the gap between them is, say, seven years, you could change your beneficiary from the elder to the younger after you’re done paying for the elder one.

Does My 529 Plan Expire?

Your 529 college-savings account does not expire and can serve multiple generations because it allows you the option of switching the beneficiary without penalty. But only as long as the new beneficiary is related to the prior beneficiary, which includes you, your spouse, younger siblings, adopted or foster children, nieces and nephews, even aunts and uncles!

Tax Benefits Of 529 Plans; 10% Penalty

529 plans offer special tax benefits—and this is what makes them very interesting. Earnings in a 529 plan are not subject to federal or state tax if withdrawals are used for qualified college expenses. Therefore, if you started early enough and the accounts have grown in value, you will be able to use that money without paying any tax. Remember, however, that if money from a 529 plan is not used for an eligible college expense or is used to pay for someone other than the beneficiary, you’ll be subject to income tax and an additional 10% penalty on the earnings portion of those payments.

Most states give you a state tax deduction on 529 plans they sponsor, but only a few states allow deductions on contributions made to non-state sponsored plans.  So, check your state’s 529 tax laws.

Investment Options

Upon opening a 529 plan, the account holder can choose from a variety of investment options such as stock mutual funds, bond mutual funds, money market funds, and age-based portfolios that automatically shift to more conservative investments as the beneficiary gets closer to college-age. Although there is some discontent with these in the investment community, I like the age-based option because it helps protect the fund from market volatility as your child gets older.

There is some flexibility with these investment choices because you can switch in and out of investments—but only once every year—so this is not a trading account that you can actively buy and sell in.

Fees And Expenses On A 529 Plan

529 plans generally carry enrollment fees, annual maintenance fees, asset management fees, and “loads” for broker-sold plans, and these expenses vary based on the investment option you select.  So carefully review all fees for your preferred investment option before you sign up.  To minimize fees, you’re generally better off buying a 529 plan directly through the state because you pay no sales fees and the state may subsidize other expenses.

Investing In A 529 Plan Can Impact Financial Aid Eligibility

Okay, this is something I want you to pay attention to. A 529 plan generally reduces a student’s eligibility for need-based financial aid because the assets held in your plan are treated as your family’s contribution to college costs.  That’s not a bad thing because it saves financial aid money for those who really need it, but it may have an effect on the amount of financial aid your child will get.

Front Load Your 529 Plan For Better Compounding

Here’s something else I’d recommend: If you have a fair amount of capital, you could front-load a 529 plan with up to five-times the annual gift allowance of $14,000 for individuals (and $28,000 for couples). So at 5x, you could load it up to either $70,000 or $140,000 per beneficiary in a single year without triggering gift-tax reporting, but if you make a 5x contribution, you cannot make additional gifts to that beneficiary for the following four years. So as opposed to giving someone $14,000 every year for the next five years, the IRS lets you roll that up into a one-time contribution of $70,000.  The advantage of this is compounding because you may end up with more at the end of the five-year period than if you had contributed $14,000 every year.

What If Your Child Gets A Scholarship?

What if you have a bright kid that wins a scholarship and there are funds left over in the 529 plan??

Well, if she won a scholarship, you’re in luck because you can withdraw, without any penalty, an amount equal to the scholarship money in the year that she received it, and you’ll only have to pay income tax on the earnings portion of the withdrawal.  So, that’s a nice feature.

Is A 529 Plan Right For You?

Finally, is a 529 plan right for you? Well, it depends.  Before you start saving specifically for college, you should consider your overall financial goals such as buying a home, saving for retirement, or paying off high-interest credit card bills.  After that, if you have money that can go towards college expenses—money that you can lock away and not touch for several years—then talk to a financial advisor about whether a 529 plan is your best option because there are other tax-advantaged ways to save for college, such as through Coverdell education savings accounts, Uniform Gifts to Minors Act (“UGMA”) accounts, Uniform Transfers to Minors Act (“UTMA”) accounts, tax-exempt municipal securities, and savings bonds.  You could, of course, also save for college in a taxable account where you have greater investment choices and can withdraw money anytime if you need to.

That said, with tuition and college expenses soaring year on year, I do believe 529 plans are a good way to save for college for most Americans.  And I highly recommend that you look into setting this up early, perhaps as soon as your child is born, then put some money into the plan every year and let compounding work its magic over the next 18 years or so until your newborn is ready for college.


Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. The information contained herein is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances. There are no investment strategies, including diversification, that guarantee a profit or protect against loss. Past performance doesn’t guarantee future results. Equity investing involves market risk, including possible loss of principal. All data quoted in this piece is for informational purposes only, and author does not warrant the accuracy, completeness, timeliness, or any other characteristic of the data. All data are driven from publicly available information and has not been independently verified by the author.
Section 529 plans are not guaranteed by any state or federal agency. Before investing in a 529 plan, please read the plan disclosure document and other relevant documents carefully. Also, consider the investment objectives, risks, charges, and expenses carefully. As with other investments, there are generally fees and expenses associated with a 529 plan.
United Capital does not provide tax advice. The tax implications should be discussed with your legal and/or tax advisors because they can vary significantly from state to state. Also note that most states offer their own 529 plans, which may provide advantages and benefits exclusively for their residents and taxpayers. Investments in college savings plans that invest in mutual funds are not guaranteed by state governments and are not federally insured. Please remember there’s always the potential of losing money when you invest in securities.

Sources:
https://www.irs.gov/pub/irs-pdf/p970.pdf
https://www.fidelity.com/529-plans/what-is-a-529-plan http://apps.finra.org/investor_Information/Smart/529/Smart%20Saving%20for%20College.pdf
https://www.sec.gov/reportspubs/investor-publications/investorpubsintro529htm.html
https://www.wsj.com/articles/can-a-529-last-forever-1502071740
https://fafsa.ed.gov/FAFSA/app/

Steve Pomeranz
I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.