Most parents probably agree that education is the best investment in a child’s future. Consequently, steadily-rising college tuition is of grave concern among this faction. In like paternalistic fashion, Uncle Sam has responded to this widespread worry by providing a means to accelerate and automate saving money for educating the next generation. His novel invention of well-intentioned intervention is commonly known as a “529 college savings plan.”
What Is a 529 College Savings Plan?
These specialized savings accounts are named after common statutory ancestor 26 U.S.C. 529 of the Internal Revenue Code. Although spawned from federal legislation, these educational funding programs are administered by state agencies and individual institutions of higher learning. Specifics vary somewhat, but the common theme of all 529 savings schemes is maximizing the value of present deposits toward future college costs.
Dual Paths to Same Destination
Section 529 plans exist in two distinct formats: “prepaid” and “savings.”
Contributors in this 529 plan category essentially pay for tomorrow’s tuition with today’s dollars. Thus, long-term investment yield depends entirely on the overall level of tuition inflation. There are two sub-categories of prepaid 529 plans: “state” and “independent.” In state-run prepaid 529 plans, funds are applicable toward attendance costs at specific in-state post-secondary institutions. Independent prepaid 529 plans are administered by private educational institutions and funds are applicable only to future attendance costs at participating private school(s). Funds transferability to non-participating academies is restricted and typically results in partial forfeiture of account balance.
In 529 savings plans, investment yield directly correlates to the performance of underlying securities, most often mutual funds. Initial deposits are generally invested in high-yield asset categories with correspondingly higher risk. As beneficiaries grow closer to high school graduation, investment strategy becomes increasingly conservative. While all 529 savings plans are state-administered, most administrative and accounting functions are usually outsourced to private financial services providers.
Although some states allow full or partial tax deductibility of 529 plan deposits, federal law doesn’t. Despite this, interest accumulation on deposit principal is tax-deferred and distributions are tax-free. Moreover, as depositors retain account ownership, they may withdraw funds upon demand, subject to full taxation and an additional 10-percent penalty for “non-qualified” withdrawals.
Although reclaimable at any time, 529 savings funds are excluded from donors’ estates for tax purposes. This makes these educational funding tools suitable to serve double duty as estate planning devices. Contributors enjoy tax exemption without relinquishing ownership or control of a valuable asset.
Virtual exclusion from financial aid eligibility calculations is an especially valuable feature. No more than 5.64% of gross balance in parent-owned 529 plans may be included in financial award calculations. Finally, beneficiary substitution is freely available without penalty at any time.
Limitation of allowable investment asset categories is the main drawback of 529 plans. Two tax-related drawbacks are the fact that IRS regulations currently allow just one tax-free asset exchange or reallocation per annum and all contributions decrease the maximum amount of a one-time estate/gift transfer tax exemption.
Non-parent-owned 529 accounts may decrease the beneficiary’s eligibility for need-based federal financial aid by 50% of fund balance. Grandparents and other generous relatives can circumvent this, however, by assigning account ownership to the beneficiary’s parent(s) or the beneficiary, but retain custodianship.
Prompt Planning Pays
All things considered, 529 college savings plans can be a painless way to provide posterity with a lifelong positive legacy. Begin breaking ground to build a brighter tomorrow for your child by visiting the College Savings Plan Network (“CSPN”) official website at http://www.collegesavings.org/index.aspx.
CSPN’s site features many helpful tools such as a side-by-side comparison of multiple 529 savings plans, contact information for plan administrators in every state, and future account balance estimators. An abundance of educational content to help you choose a plan that best suits your goals and budget is also readily available.
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