A 2-part series in honor of National 529 Day, here are some things you may not know about 529 plans.
By Brenden Leese
Numerous studies show that 529 plans are one of the most effective ways to save for college. 529 plans offer tremendous flexibility and tax advantages. You don’t have to use your home-state’s plan.
Anyone, regardless of income level, can save and contribute (any time to a 529).
Find out why we advised one successful couple not to overfund their children’s 529 plans—even though they could afford it.
For the first time in over a year, extended families may finally get together (in person) over Memorial Day weekend. While the focus will be on fun, sun and maybe a parade to honor those who served our country, thoughts will eventually turn to graduations and how we’ll be taking care of future generations. Incidentally, May 29th is National 529 Day.
According to the College Board, the average private college charged students nearly $47,000 a year to attend—closer to $70,000 a year for children of successful professional families. If that’s not jaw-dropping enough, Sallie Mae research found that only half (56%) of American families with children have started saving for college—and if they have, only $18,000 on average has been salted away. Even among families with 6-figure incomes, Sallie Mae data found that the average amount saved for college was less than $30,000.
That’s a big gap that needs to be filled by scholarships, merit aid or student loans. Perhaps that explains why youth sports are so competitive in our area. But according to NCAA data, only about 2 percent of high school athletes are awarded some form of athletics scholarship to compete in college—and the average scholarship amount is only about $10,400. Bottom line, don’t bank on a scholarship. The chances of receiving a full-ride academic scholarship to a high-profile private college are not much better.
That’s where 529 Plans come in.
A 529 plan is a tax-advantaged savings plan designed to help pay for education. The two major types of 529 plans are (1) savings plans and (2) prepaid tuition plans. Savings plans grow tax-deferred, and withdrawals are tax-free if they're used for qualified education expenses. Prepaid tuition plans allow the account owner to pay in advance for tuition at designated colleges and universities, locking in the cost at today's rates. We’ll talk more about prepaid tuition plans in a future post.
Study after study shows that 529 Plans are one of the most effective and tax-efficient ways for families to save for the ever-rising cost of college. They offer bigger upside and fewer income limits and restrictions than an UGMA, UTMA, Coverdell or good old-fashioned savings bond.
Here are just some of the benefits of 529 plans:
Contributions grow tax-deferred and are withdrawn tax-free if used for your child’s/beneficiary’s qualified education expenses.
You may contribute between $235,000 and $529,000 in each of your 529 accounts, depending on which state’s plan you use.
You can make a lump sum contribution or make smaller regular contributions on any schedule you choose.
Anyone can open a 529 plan, regardless of income level.
You may now use up to $10,000 a year of your 529 for K-12 tuition.
Many plans offer target date and age-adjusted investment options. They do the asset allocation and rebalancing for you automatically.
The SECURE Act expanded tax-free 529 withdrawals to include registered apprenticeship program expenses and up to $10,000 in student loan debt repayment for both account beneficiaries and their siblings.
Any money that’s left over in the account after college can be applied to graduate school or transferred to another family member for their higher education pursuits.
No tax reporting or 1099’s are required.
You do not have to invest in your home-state’s plan.
Up to $10,000 a year in contributions may be deductible from your state income tax calculation.
Here are some frequently asked questions that we get from clients about college savings:
When is the best time to start a 529 account for my child or grandchild?
Start saving when your children are very young to maximize the power of compounding. Some folks make a lump sum contribution when their kids are infants or toddler (more on that in a minute). Others make smaller regular contributions on a monthly, quarterly or yearly basis. The key is to save with the assumption that your children will not receive any substantial scholarship or financial aid to attend the college of their choice--and if they do, it will be a huge bonus, not a lifeline. Regular contributions also help smooth out stock market volatility which can affect your savings, especially in your child’s younger years. Think of it as dollar-cost averaging for college savings. How much should we be saving?
Tuition costs differ for these different options. When your children are young, it’s hard to know where they will ultimately attend college—if at all. But here are the average costs (in today’s dollars):
Private university: Over $40,000 per year.
Public Out-of-State: $21,000 annually.
Public In-State: $10,000 annually.
Talk to your advisor to discuss the best funding options based on the needs you wish to fund.
Real World Example
We work with a successful professional couple in their mid-40s who have children aged 11 and 13. Both parents have high paying jobs. While they valued education greatly, they told us they weren't obsessed with sending their kids to elite private universities and didn’t want to overfund their 529 accounts. In fact, they thought it might be good for their kids to take out a student loan for college, so they’d have “some skin in the game.”
Thanks to some financial windfalls and work bonuses, both parents had plenty of cash on hand. After working through the analysis and showing them different scenarios, we collectively decided that the 5-year lump sum contribution for each child was a good compromise and provided the most flexibility. Based on conservative growth expectations, that lump sum contribution should accomplish their goal of funding college for their kids without over-contributing.
Since both parents expected to keep working for the foreseeable future, they felt they would be in a strong position to reassess financing any shortfall in their 529 plans if the account did not grow as expected, or if their children chose to attend an extremely pricey private school.
In Part 2 of this series, we’ll discuss 529 investment timing and strategies, asset allocation, contribution limits and whether or not you are limited to your home state’s plan.
On this first summer weekend of the year, many families will be taking stock of the progress we’ve made over the past year—and will resume looking hopefully toward the future. If you or someone close to you has concerns about college savings for your children or grandchildren, please don’t hesitate to reach out. We’re happy to help. BRENDEN LEESE is a Paraplanner at Novi Wealth