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To 529 or not to 529

As a parent who’s first born started college this year, college funding and expenses are top of mind in my household. Clients we work with who have kids from 1 to 18 years old seem to have the same concerns. Let’s explore some of the ways that a family could use a “529 Plan” for education savings.

Why the 529? College expenses are consistently on the rise, at an average increase of 3% per year, and 529 accounts can help to pay for the expense. Some attractive factors are the tax-deferred earnings and tax-free withdrawals to pay for qualified education expenses.

One common issue with 529s is a lack of clear understanding about how flexible these accounts can be. For example, most people are not aware that one 529 account can be used to benefit multiple students within one household. An account be opened, funded over time, and then used systematically for each child as the family incurs college related expenses.

529 plans have very specific transferability rules, governed by the federal tax code (Section 529). You may transfer the plan to another family member, defined as:

    • Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them
    • Brother, sister, stepbrother, or stepsister
    • Brother or sister of father or mother
    • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law
    • Father or mother or ancestor of either
    • Stepfather or stepmother
    • Son or daughter of a brother or sister
    • The spouse of any individual listed above

In the event one child opts not to attend college, you can change the beneficiary to the next most likely college bound sibling or family member. If all of your kids have completed college, you can change the beneficiary to a grandchild. Should your child become disabled, your distributions can be withdrawn tax-free as well. You can also use up to $10,000 of 529 funds for K-12 tuition expenses per year.

How can the funds be spent? Here’s where we learn a very important term: Qualified Distributions. Qualified Distributions must be tracked and accounted for, and can cover any of the following:

529plan distributions are tax-free when the funds are used to pay for qualified expenses and up to $10,000 in K-12 tuition expenses per year. Qualified higher education expenses can include:

    • Tuition and fees
    • Textbooks, supplies and equipment
    • Certain room and board costs , if the student is enrolled in an eligible college program on at least a half time basis
    • Computers and internet access
    • Special needs expenses

As you can see, there are many benefits and options available to you through the use of the 529 Plan account. Funding these accounts comes with flexibility as well. In our family, we use the Idaho 529 Plan, through Idaho College Savings Program. The website even provided links to share with grandparents, so that they could contribute to the 529 savings as well. Here at Fulcrum, we’ve worked with clients to make distributions from their investment accounts into a 529 Plan owned by their children, for the benefit of the grandchildren. Some states offer state sponsored plans that provide a tax benefit on contributions as well. As always, consult your tax professional for advice.

While saving for your kids or grandkids college expenses is an important part of a financial plan, and 529s are a tax advantaged resource to do so, let me also share a “word to the wise.” Grades, Grades, Grades!!! We knew that grades were an important factor for our oldest as she went through high school and approached college applications. What we did not appreciate at the time, was the nearly one to one ratio of her high school GPA to Academic Merit Scholarships available at nearly every college we researched. Go to any college website and search, “Merit Based Scholarship.” In most cases you will find a grid that shows how much academic scholarship you can earn with a solid GPA and/or test score. We have found that walking our kids through the website of a school they are interested in, and pointing out the savings that they can earn, has been a great motivator to work hard in the classroom and see a direct benefit from getting great grades!

Lastly, the “what if?” As in, what if we contribute to a plan like this and don’t use the funds for education or college related expenses? That’s where you will end up paying ordinary income taxes on the gains on the investments, and a10% penalty for “non-qualified” withdrawals. However, you will still have benefitted from the tax-deferred gains in the interim. And, with the transferability of these plans, they can be kept in your family for a longtime, potentially providing a benefit to multiple generations, without paying unnecessary taxes and penalties.

Together, we can work to keep you on-track towards your financial goals. Request a consultation with me to learn more.

Read more articles by Justin Samples