When you’re saving for your child’s future education, it's important to know which tools are available to help since higher education has become so expensive. One tool you've probably heard of, but may not know much about is the 529 Plan. More and more it is becoming the savings vehicle of choice for college savings and can be utilized in ways you may not have considered.
So for today's post, let's take a crash course and answer some of the commonly asked questions about 529s:
What can my child use 529 money for?
The money can be used to pay for qualified expenses such as tuition, fees, books, supplies, computer-related costs, and room and board for someone who is at least a half-time student, including at community college, trade or vocational school. Pizza, burritos, and beer unfortunately don’t qualify yet.
How much can I contribute?
This answer is not as straightforward as with an IRA or 401(k) plan. Generally, contributions to a 529 Plan max out at $350,000 per beneficiary, but there are some caveats to getting to that amount.
You need to be careful of federal gift tax laws. A gift of more than $14,000 (married couples up to $28,000) to a single person in one year could cause gift tax consequences. There is also a "front-loading" provision where a 529s allow an individual to potentially contribute up to $70,000 (married couples up to $140,000) tax-free in one year to an account for a beneficiary. For tax purposes, the amount is spread out over five years.
The good news, there are no age or income restrictions to contribute, and even for the majority of us not saving close to $14,000 per year; any amount contributed to a 529 receives tax-advantaged status.
What if our relatives want to contribute?
Family members can either open a 529 account and name your child as the beneficiary or kick into an existing 529 that you own. We typically recommend relatives keep separate accounts for a variety of reasons including financial aid, avoid commingling fund, and potential tax benefits.
If your family members contribute to a 529 account that they own, they may receive a state tax benefit, if their state offers a deduction or credit. Another reason to keep separate accounts is found here in Indiana we have a 20% tax credit up to $1,000 per year on 529 contributions. So keeping the accounts separate pays off for you and Grandma and Grandpa.
Why use a 529 over a regular taxable account?
As briefly mentioned earlier, 529 accounts defer taxes and your contributions grow tax-free as long as you use the funds on the qualified expenses listed in the first question.
This beats paying the government for an after-tax account – but the latter does offer complete flexibility on where and how you can spend the money. A 529 doesn’t.
What if my child gets a full scholarship?
Good news... the government will not penalize you if your child is brilliant. In fact, they encourage it!
You can withdraw from the 529 without penalty, though you do pay taxes on the earnings at the scholarship recipient’s tax rate. However, before doing that, remember you can also use your 529 to pay for expenses that the scholarship doesn’t cover, such as room and board, books and other required supplies.
In addition, you can keep the 529 open with your child as beneficiary if he or she plans on graduate school, or you can also change the beneficiary and name another college-bound child.
What if my child does not want to go to college?
You can change the beneficiary to another family member (a sibling, first cousin, grandparent, aunt, uncle or yourself, for example), and the money goes toward that person’s education. Most plans allow you to change your beneficiary only once a year, but if your child has a change of heart and does decide to attend college, you can rename that child the beneficiary.
Remember too that these funds can help pay for two-year associate degrees, as well as for trade and vocational schools.
A last ditch option: Withdraw the money, or cash out the plan. You pay income tax and a 10% penalty on the earnings, but not on your contributions. But, if unsure that your child is in fact headed for higher education, sit tight on cashing out. One thing about young adults: life can always change in the blink of an eye.
If you have any questions or would like assistance evaluating saving for college and how a 529 Plan should fit into your finances, we’re happy to help! Learn more at www.AnExceptionalLifeFinancial.com or get in touch at Info@AnExceptionalLifeFinancial.com.
Mychal Eagleson, CFP®, AAMS® is the President of An Exceptional Life Financial, a firm that specializes in financial planning for teachers and families with special needs. He frequently writes and speaks regarding personal finance topics relating to these clients. Mychal also serves on the board of the Financial Planning Association of Greater Indiana as the Director of Public Relations & Social Media. To read more of his articles or learn about An Exceptional Life Financial please visit: www.anexceptionallifefinancial.com.