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Should I invest in a 529 Plan for My Kid’s College Expenses?

 

If you start saving when your kids are young and you have 10 or more years between now and when you need to use the college savings funds than you should definitely consider investing that money instead of letting it sit in a savings account earning little to no interest.

With a stretch over a decade or more, investing can help you take advantage of compounding returns that should contribute substantially to your investment into your child’s future.

Many people saving for college choose 529 plans as their investment vehicles because the 529 plans offer tax advantages that you cannot get with other savings programs.

One of the many benefits of saving for a child’s future college education with a 529 plan is that contributions are considered gifts for tax purposes. In 2019, gifts totaling up to $15,000 per individual will qualify for the annual exclusion.

529 plan contribution limits are set by the states and can be as high as $380,000. However, to avoid gift tax consequences, federal law allows single taxpayers to contribute up to $14,000 in one year or make a lump-sum contribution of$70,000 to cover five years

There are many options available for 529’s, and you’re not limited to just your own state’s plan. As a matter of fact, if you are considering a 529 you will want to look at the details on a per state basis. You may find a plan that offers lower fees and better-quality investment options than what is being offered in the state that you reside in.

 

Can you write off 529 contributions?

Unfortunately, you can’t claim a federal income tax deduction for contributions that you make to your 529 plan. With that said, certain states offer state income tax deductions for contributions to 529 plans. You should check with your individual 529 plan or your state’s taxing authority to determine the tax treatment in your state.

 

What happens to a 529 plan if the child passes away or becomes handicapped and unable to use it?

You would then be able to transfer the fund to a family member or withdraw the money and pay the taxes on it, but If you withdraw your 529 funds because your beneficiary dies, becomes disabled or has earned scholarships and doesn’t need the money, the 10 percent penalty may be waived in most cases.

 

Can you use a 529 to pay off student loans?

You cannot use a 529 college savings account to pay off student loans. Unfortunately, student loan payments are not a qualified withdrawal. 

But you can use a 529 plan to pay for tuition, fees, room and board, books, computers, and many other college-related expenses, without tax implications or penalties.

 

Do I need to report 529 contributions on taxes?

If you’ve simply been contributing to an existing 529 account, you may not have to report anything on your federal income tax return. Unlike an IRA, contributions to a 529 plan are not deductible and therefore do not have to be reported on federal income tax returns.

 

Do 529 distributions count as income?

The 529 is not counted as an asset on the FAFSA form, but like non-custodial parents, withdrawals from the 529 plan are counted as student non-taxable income and up to 50% of the value of the withdrawal could impact financial aid.

 

Does each child need their own 529?

It is recommended that each child have their own account. By having separate accounts, your children can each set individual goals to work toward. 529 plan contributions are considered gifts for tax purposes, and up to $15,000 (in 2019) per beneficiary qualifies for the annual gift tax exclusion. In addition, 529 plans can only have one beneficiary.

 

Are there any downsides to a 529 Plan?

Before you start funding a 529 plan, know that it might be wise to only invest money that you know will go toward qualified educational expenses because while a 529 plan remains a great way to save for college, it lacks the flexibility of other accounts as you can only make tax and penalty-free withdrawals for educational expenses. You’re basically earmarking this sum of money for education only.

No question, there are tax benefits to using 529s. If you invest $10,000 and it grows to $20,000, for example, that growth is tax-free, so you don’t pay dividends or capital gains taxes like you would on growth in a regular brokerage account.

But, don’t forget, if for some reason the money isn’t used for qualified education expenses, then you will have to pay a 10% penalty on the growth as well as the taxes on the amount that does not get used for educational purposes.

On a positive note if your child gets a full scholarship, the 10% penalty is waived, and in addition, if your student isn’t going to utilize the whole fund for some reason you can transfer the account from one beneficiary to another within your immediate family with no penalty. You can even use it for your own education and there is no penalty for that either, as long as it is being used for education.

If you need flexibility because you aren’t sure how much you’ll be able to contribute to your child’s college education, or how much it will cost when the time comes, or even if your child will stay in school at all, a brokerage account might be a better choice for you.

With a brokerage account you can use the invested money for whatever you want, and in many cases, you might earn even more return on your investment depending on the vehicle that you use. There are no penalties for using the money for non-education costs if that’s what ends up happening. The only downside here is that there’s no specific tax advantage in a regular investment account.

That being said, it really is a good idea for parents to open 529 plans for their kids even if they don’t want to put their own money into the accounts. Why? Because it makes it easier for other people to help you save for the cost of college.

Even if you’re not sure how you will fund it (if at all), open a 529 plan so that grandparents, aunts and uncles, other family members or family friends can contribute to it.

If you have questions about saving for your child’s college, or need assistance setting a college fund up, please contact our office at 248-524-5240 for a free consultation.