OK — maybe it’s not your parents. But, if not, then it must be your roommate’s.
That’s not only shocking, it’s tragic.
Because student loan debt has recently eclipsed credit card debt, which has huge implications for grads, their parents and the economy. And, because — despite a dizzying array of 529 plan choices and some admittedly confusing differences in tax treatment state-to-state — 529 plans are arguably the best way for most American families to save for college and help reduce their possible future debt burden.
In defense of your parents, there is a lot of misinformation and conflicting opinions about the benefits of 529 plans. So, here are the crib notes for “529 Plans 101.”
The earnings of every 529 plan — regardless of which state you reside in or go to school in — are not taxed, provided you use the money for “qualified” college expenses, which include tuition, fees, room & board (on or off-campus), books and supplies.
In several states, your parents may take a state tax deduction for some or all of their “contributions” (deposits). In my state, New York, for example, I can lower my taxable income by up to $10,000 per year, if I put that much or more in either or both of my daughters’ 529 accounts.
The money can be used at virtually any higher ed institution — community, vocational, state or private 4-yr, or grad — in the US, and hundreds of schools abroad. If the school is in the FAFSA database, you’re fine.
If your parents are dissatisfied with the plan they’re in, they can “rollover” the account to any other plan, provided they haven’t done so in the last 12 months.
What happens to the money if you don’t use it? The account owner has many options. Any unused monies can be:
a. Transferred to another 529 account, or the “Designated Beneficiary” (the person for whom the money is ultimately intended) can be changed to anyone related to the original beneficiary.
b. “Distributed” (withdrawn) at any time. It’s important to note that if the money is not used for qualified college expenses, the recipient will be responsible for ordinary income tax on any gains, as well as a 10% penalty on any earnings.
c.Left in the account indefinitely. With the exception of just one state (VA), there are no age or time restrictions on how long a 529 account can be held.
There are over 90 different 529 plans today, so — as you can imagine — they differ widely.
But, all have pre-determined investment choices. Most invest in mutual funds. Others invest in ETFs, CDs, Money Market Funds, Guaranteed Investment Contracts (GICs) and SDIC-Insured instruments.
Many Americans simply invest in so-called “Age-Based” portfolios, which automatically get more conservative over time — moving from an equity (stock) heavy allocation when the child is young, to one composed of fixed income (bonds) or cash by the time the Beneficiary reaches 18.
To be clear, with the exception of GICs and SDIC-Insured instruments, all 529 plan investments carry risk — to the extent that they invest in financial markets. But, a diversified portfolio — invested over the long-term — will have a better chance of helping you defray the cost of college than sticking your money under the mattress.
It’s important to know what the fees are for the investment you choose. Most are reasonable and justified given the beneficial effects of tax-free compounding, which should minimize the bite that fees will take out of earnings. But, some plans have fees so high, they could cancel out the benefits of any tax savings.
There are a few restrictions on all 529 plans beyond those discussed above.
You can only change your investment allocation (the combination of portfolios you’re invested) once per calendar year.
All states have a “maximum contribution limit” (the balance, which, once reached, precludes the owner from making further contributions). However, each state’s limit is different.
The good news is most of us are in no danger of hitting that limit, as it is in excess of $250k in most states.
Additionally, investors in 529 plans — like in all other types of investments — are bound by the federal gift tax guidelines, which currently prohibit “gifting” more than $13k per year, per beneficiary.
As you know, that amount won’t even cover a single semester at many schools. But, there’s more good news: there’s a special provision in the tax code that allows you to effectively “borrow” your future annual gift tax exclusion, so your parents can put up to $130k into an account at one time, if they file their taxes jointly.
Tell them to ask their accountant how to do this using IRS Form 709.
Effect on financial aid – it’s complicated
Suffice to say: very few college students are eligible for significant amounts of needs-based financial aid. So, not saving for college because you don’t want to jeopardize your chances for financial aid is rarely a wise strategy.
And, because a 529 plan account is generally considered the asset of the parent, less of that money is considered in the “Expected Family Contribution” than if the money was in the student’s name (e.g., in an UGMA account).
For more details, visit the Savingforcollege.com website.
Unless you’re a trust fund baby, or your grandmother is writing out checks for your tuition, chances are investing in a 529 account makes good sense for your parents — and you.
The cost to attend college is rising on average at a rate roughly twice inflation. But, that’s just the average.
Many schools — most being state schools in states mired in fiscal crises like California — have raised tuition 20% or more in the last year. Meanwhile, chances are your parents’ income has been stagnant for the last decade.
But, the most compelling reason to invest in a 529 plan is to avoid having to take on more debt than necessary.
Whether it’s you or your parents who will pay that student loan tab, it’s better to invest than borrow. Typically, every dollar invested in a 529 plan, held for a 10-year period, has the potential to reduce the cost of attendance by 1/3 or more.
Is it too late?
Saving in a tax-advantaged account — even if it’s just for a year — is typically better than keeping your money in a taxable account. And, if your parents live in a state that allows them to take a tax deduction for making a contribution to a 529 plan, why wouldn’t they invest in one — especially since most plans have no restrictions against making a contribution, and then taking a withdrawal the same academic year.
So, send a link to this article to your parents, tell them to study up, that there’ll be a quiz when you come home for fall break, and if they fail, you’re taking away their car keys for the semester.
He is a former Executive Committee member, and former Chair of the Government Affairs Committee for the College Savings Foundation (CSF), a non-profit organization dedicated to the advancement of 529 college savings programs. CSF’s mission is to help American families achieve their education savings goals by working with public policy makers, media representatives and financial services industry executives in support of education savings programs.
And, he is the proud parent of a daughter headed to her freshman year at The College of William & Mary this fall.
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