When parents welcome a new child into their family, they’re hit with many numbers—date and time of birth, length and weight of the baby. But in the early years, many families neglect to consider three very important numbers that will affect their estate and their child’s future: 529.
While 529 plans have been available for almost 30 years, individuals are now realizing that they are an effective tool when saving for secondary education. A 529 plan allows investors to grow dollars tax-free while saving for their children’s education. Yet despite families being savvy to these opportunities, there’s a lingering hesitation to go through the motions of setting up a tax-advantaged account—especially among those who are unburdened by the cost of higher education.
If you’re reluctant to set up 529 accounts for your children, allow us to address your questions and concerns.
I can afford to send my kids to college—so why bother with a 529 plan?
Regardless of whether you can afford to pay for your children’s college education, you can realize tremendous tax-free growth in a 529 account while also transferring dollars out of your estate. Withdrawals for qualified college expenses are exempt from federal income taxes, and contributions may earn tax deductions or credits depending on the plan.
While there are many 529 plans from which to choose, you want to keep factors in mind such as cost, investment options and tax deductibility. If you live in a state that offers deductible contributions, you may be required by the state to invest in its specific plan in order to receive the tax deduction. If there are no state restrictions on the deductible contributions, then we typically advise clients to explore the Utah Educational Savings Plan, which consistently has low overall costs and offers a diverse set of investment options.
An advantage of a 529 account is the ability to take money out of your estate without compromising control of those funds. Your contribution is treated as a gift to the beneficiary, so it can be applied against your federal gift tax exclusion. This enables you to make a contribution of up to $14,000 per year without incurring the gift tax.
But here’s where the true value is: 529 plans allow you to contribute a lump sum of up to $70,000 in the first year (per grantor), and spread it equally over the next five years. The gift will no longer be considered part of your taxable federal estate and will qualify for the gift tax exclusion each year. This can benefit those whose assets exceed the estate exemption amount for federal estate tax, which is $5.45 million per individual or $10.9 million per couple. (An exception would be if you were to pass away in that five-year period, then the attributable would come back into your estate.)
What if my child doesn’t go to college?
Critics of the 529 plan will point to its rigidity, as non-qualified earnings withdrawals will be subject to federal income tax and a 10% penalty. However, if your child opts out of attending college, you can change the beneficiary to another family member, or even yourself!
Keep in mind that 529 assets can also be used at many technical institutes, culinary and beauty training schools and international schools. So if your child doesn’t want to attend a traditional university, his or her education can still be funded with the 529 plan.
What if my child receives a scholarship?
There are some exceptions to the 10% penalty imposed for non-qualified purchases, and a scholarship is one of them. You can withdraw funds up to the amount of the scholarship without penalty, but you may need to pay income tax on the earnings.
Depending on the plan, you can also hold onto those funds for graduate school. In addition, Congress recently passed legislation that adds computers and core technology needs to the list of qualified education expenditures, which includes tuition, room and board, and books.
Is this just another account I’ll need to actively manage?
Like your 401(k), 529s are limited to the investments included within the state’s plan. Also similar to saving for retirement, we recommend investments become increasingly conservative as the child approaches college age. This is a relatively low-maintenance plan that many families “set and forget” outside of regularly making contributions.
Although it may be difficult to imagine your toddler in a graduation cap, saving for his or her education can offer significant near-term benefits to your estate and many long-term advantages for your child’s future. Contact Wescott Financial to learn more about 529 plans and additional college-planning strategies.