8 Myths About 529 Plans
Source: Fidelity 2020 College Savings Indicator
529 College Savings Plans are a popular way to provide for your child’s college education. However, myths about these plans exist and prevent families from understanding the full value of this tool. In 2020, Fidelity found that parents utilizing a 529 had a median of $30,000 set aside for college vs. the $10,000 of parents not using a 529. Additionally, those 529 users were on track to cover 46% of their college savings goal vs. only 24% coverage for those not using a 529 (Source: Fidelity). If you’re seeking to be more prepared for your child’s college costs, don’t let these myths stop you.
Myth #1: It’s the same as paying for it out of my regular investment account.
The big advantage of a 529 is the allowance for federal tax-free earnings growth and tax-free withdrawals on qualified higher education expenses. Some states even offer tax deductions or credits for contributions to 529s. For people in higher tax brackets, this is an attractive gift from our government.
Myth #2: I can only open the 529 savings plan that is offered by my state.
Many states do not require residency to use their plans. There may be incentives to use the plan in your state (e.g., no state income tax on withdrawals and state income tax deductions on contributions) but the 529 plan market allows for competition so you should compare the features of all the different plans before choosing. Fees can vary widely, and some include higher minimum contributions than other plans.
Myth #3: Only parents can open 529 plans for their own children.
It is also important to keep in mind that 529 plans are relevant tools to more individuals than just parents. You do not need to have a child to begin considering these as a part of your financial picture as you can give to nieces, nephews, or any other beneficiary.
For the generations that may be concerned about potential estate taxes (e.g., grandparents or great-grandparents) and want to move assets outside their estate, 529 plans can be a great option. Or perhaps you are an aunt or uncle that would prefer not to purchase another stuffed animal as a birthday gift but would rather put that money towards future education costs (or maybe you do both!). And for couples without kids (but want to have kids or adopt), you can open a plan under your own name (change the beneficiary later) and begin saving towards your future child’s education today. The flexibility of 529 plans makes them relevant to more than just current parents which makes the benefits more accessible to a broader range of savers.
Myth #4: I can only contribute up to the state plan’s limit.
Individual donors can contribute $16,000 (in 2022) per year to any account. With “superfunding” investors can contribute 5x the annual gift exclusion (currently $80K) to a beneficiary in one year without facing a gift tax penalty. Keep in mind this puts limitations on future contributions and/or gifts in the next four years because superfunding treats the gift as if it came in over a five-year period. And if you superfund, you need to file a special tax filing to avoid the gift tax.
Myth #5: I will waste the money if my child does not go to college or pays for college another way.
The donor maintains flexibility to change the beneficiary of the account. If your child decides not to attend a qualified institution or the cost is covered by scholarship, you have many other options.
Save for K-12 private education expenses. In 2018, the IRS included elementary or secondary public, private, and religious schools in the definition of “qualified higher education expense.” The limit is $10,000 per year.
Change the beneficiary on the account to another family member without tax consequence.
Roll over the 529 assets into a plan for the benefit of another family member.
Pay off up to $10,000 of existing student loans for any family member.
Rollover up to $16,000 (in 2022) into a 529 ABLE account for your child or family member with disabilities to save and independently maintain funds for qualified expenses. (Read our blog about special needs financial planning).
Withdraw the assets with a tax penalty. If this is your only option, you will pay federal income tax and a 10% penalty on the earnings (unless the child gets a full scholarship to college, and then the penalty is waived).
Myth #6: 529 savings impact my child’s ability to receive financial aid.
When structured properly, a 529 plan may not reduce need-based financial aid opportunities through FAFSA. The Free Application for Federal Student Aid (FAFSA) form provides an Asset Protection Allowance which protects ~$10,000 of parents’ assets from being considered. If the 529 plan is owned by the parent, it falls under this allowance. Anything additional will reduce the amount of FAFSA the child is eligible for, but the tax-free investment gains could very well outweigh this loss of aid.
If the 529 is owned by a grandparent or other relative, these assets are not included on the FAFSA.
Myth #7: 529 savings can only be used for tuition at an in-state university.
Funds must be used at a qualified educational institution. The IRS’s list of eligible institutions includes trade schools, community colleges, graduate schools, seminaries, and even international schools.
Beyond tuition, funds can be used to cover anything the student is required to have as part of his or her college education including: Internet, Course Fees, Computers, Books & Supplies, Room & Board, Student Loan Repayment (source: IRS).
Myth #8: It’s too late to start a 529.
It’s not too late! 529s allow for tax-free growth and tax-free withdrawals for qualified expenses. Even if your child has just a few years until beginning college, you can take advantage of that tax-free growth.
You can create opportunities for generous family members to give tax-advantaged gifts to your child through 529 contributions.
Fund future education for your child (ex: graduate school).
Get a head start on your grandchildren’s educational expenses.
Consider how much you are able to contribute, the effect on FAFSA, and if there are other options for funding your student’s college.
Contact Us for Help Thinking Through College Planning
The same Fidelity study also found that 90% of the families who were working with a financial advisor had started saving for college and 79% said that working with them gives them peace of mind in the college planning process.
If you need assistance thinking through how a 529 plan might fit in your financial picture or how much you should fund for your child or family member, please feel free to reach out. We would be happy to discuss!
Resources
Schwab College Savings Calculator
Kings Path Blog, “Getting a Head Start on College Planning with a 529 Plan”
