If you have children or grandchildren and wish to save for their education expenses efficiently, you will want to look at a state-sponsored 529 plan. These plans are available in every state and vary to some degree from each other. Some may have lower fees while others may have a wider or better selection of investment vehicles. If you need assistance in selecting a state, consult a Registered Financial Consultant for their help. Otherwise, here are some helpful tips to assist you in using your 529 plan.
Tax-Advantaged
All state 529 savings plans are tax-advantaged, meaning that all of the earnings made in the account will not be subject to income tax provided that the funds are used on a qualifying education expense. This is a key factor to the plans if you open an account at birth you will have 18 to 19 years to contribute your principal and have nearly two decades for the funds to compound in your favor. And as I have shown in retirement posts the longer you let the money work for you, the better off and more you will have at the end of the process. The key here in a 529 plan is the same as a retirement account, save early and often with as much as you can.
As I alluded to earlier that not all 529 plans are created equal, and there are advantages to shopping different states plans. The state will select a plan administrator similar to what your employer does with your 401(k), and they charge management fees. Some states keep this in mind when selecting an administrator, while others will go for a wide range of investment choices. Regardless you need to be aware of the management fees and the fees of the various investments. Then there is the fact that some states will give you preferential tax benefits if you contribute to your home states plan. This means you get a tax deduction on your state income tax if you contribute to your state’s plan for a child. In some states, this is a major selling point for the plan and may make investing in a plan with higher fees or a limited selection of investments worth it due to the additional tax advantages.
Use of Funds
Funds in a 529 plan can be used for any qualified education expense that the child incurs. This means that you can use it for a four-year college or graduate school. But you are not limited to those choices as a community college, technical colleges, and even up to $10,000 a year can now be used for primary school meaning kindergarten through high school. An educational expense is defined as tuition, room and board, books and computers.
But what if your child does not attend have any qualified education expenses? You may change the beneficiary to any other of the following family members: siblings, parents, cousins, nieces and nephews, aunts and uncles, or spouse. This gives you some control over the unknown if you have a large family, you have options for the funds if a child decides not to further their education.
Choice of Schools
Okay, I live in Tennessee, and although I do not have any children if I did and my plan was in my home state, would my children be limited to universities in Tennessee? And that answer is no you are not limited to the schools within the state’s plan you choose. This means I could pick a plan in California because I like their plan, as Tennessee has no state income tax to induce me to stay within my state for the plan. Just like you are not limited to contributing to your state’s 529 plan, your children are not limited to any one state for their choice of schools. And these plans will even pay for some international education expenses, so check before you go that route.
Are the Plans Difficult?
As alluded to before, 529 plans vary from state to state in the investment options. But like your 401(k) plan, that does not mean investing in them is difficult. Many plans have funds similar to the lifecycle funds found in your retirement plans. This means that your investments are aggressive when your child is younger and gradually shift to being more conservative as they get closer to high school graduation. One extremely important thing to note here is that you can only change the plan’s investment allocation twice a year or when you change the beneficiary.
Who Can Contribute?
A parent can contribute to their own child’s account and as I stated in the opening of this post grandparents can contribute as well. But who else can contribute to a 529 plan? Well, the answer is anyone! That is what makes these plans so appealing is you can ask relatives and others to make contributions to your child’s plan in place of toys or other gifts. This is much easier to do when the child is young and does not expect such things from people. It will also allow the funds to have more time to grow making the gift much more valuable in 18 or so years instead of a $25 toy as a one-year-old.
529 plans are very versatile, as I have shown. But what if you have saved and there is no one who you want to leave the plan to? Well, you take the funds out and pay the income tax on the earnings in addition to a 10% non-education expense penalty. Not the end of the world there. What if your child earns scholarships that cover their education expenses? You may be allowed to withdraw the amount of the scholarship from the plan, but in doing so, you may be liable for the income taxes but not the penalty.
If you have any questions or need any additional assistance, please feel free to contact me directly or seek the help of a Registered Financial Consultant. To join our email newsletter, please fill out the form below.
