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Before You Write That Check: Back to School Time Is 529 College Savings Plan Time

By: Joe Delaney

It’s back to school season, an exciting time for parents and grandparents watching the next generation advance to the next step in their journey. Whether they are heading off to kindergarten, middle school, high school or about to meet their first dorm mate, it’s a good time to look at your own journey, too.

Our financial journeys are influenced by our families, like it or not, and vice versa. That’s part of why we get so excited to watch the next generation come up. We understand that to be attached in some way to their success is our family privilege.

We’re attached to their potential financial insecurity as they come up in the world, too. We know if they work hard and achieve their goals they will be more likely to be self-sufficient. Anything we can do to help is a good investment we’re more than willing to make for our children.

Before you write that check, though, hold on. There are great benefits to supporting their future in a smart way you don’t want to miss out on.

What is a 529 college savings plan?

Simply put, a 529 plan is like a savings account specifically for college. It is not literally a savings account, however; it is an investment vehicle offered through your state that can be set up in a variety of ways to try to maximize returns in time for teens to head off to college.

Who opens it?

You do. 529 plans belong to the account holder, not the beneficiary, making 529s an ideal alternative to direct gifts to the college-bound teen. If your granddaughter decides she doesn’t want to go to college after all, you haven’t wasted your investment. You can simply change the beneficiary to your grandson, the high school junior. Or even to his mother, who wants to go back and get her master’s degree. If no one uses it, you can withdraw the funds, at which point they will be subject to taxes and penalties. More on that below.

How do I choose a plan?

There are a lot of options, especially because you can shop for plans from all 50 states that offer different fees and investment options. You need to keep in mind, however, that you may be losing tax benefits by not choosing a plan provided by the state in which you are a resident. Indiana, for example, offers a generous tax creditof up to 20% of contributions up to $5,000. One of our favorites for residents of California, which does not offer tax benefits, is the Utah Education Savings Plan. (Contact usto learn more.)

Why is it better than a savings account?

Federal tax “deferred” is not exactly an accurate descriptor if a 529 is used properly. Usually we use that term to describe retirement investment vehicles on which you will pay taxes one day, once you start taking funds out. This is different in that you should never have to pay a penny of tax on it. Here’s why:

  • Although there is no federal tax deduction for 529s, many states offer tax deductions or credits to residents which offset income tax on the money you contribute.
  • Contributions are hassle free as long as they don’t exceed the annual federal gifting maximum. Currently, the federal gifting maximum is $14,000 per beneficiary per year from each contributor. Two parents could contribute $28,000, for example. There is also a five-year accelerated gift option that allows frontloaded contributions up to $70,000.
  • You do not have to pay federal tax on 529 capital gains as long as the funds in that account are used to purchase qualified school-related expenses. You are only subject to income tax (as well as a 10% penalty on gains) if you use the money for an unqualified expense or withdrawal.

The website www.savingforcollege.comis an excellent resource to learn more.

When should I open a 529?

As early as possible. Like any other investment, the power of compound interest is greatest over the longest period of time. You’ll see a much better return if you start contributing when the beneficiary is born than when they are a high school junior, though there are still some tax benefits late in the game. We tend to advise clients to make contributions consistently and consider each a line item in the monthly or yearly budget like any other.

Here at Lifeguard Wealth we urge clients who are eager to support the kids to put the checkbook down for just a moment. Before following your heart to a good place, let’s look at all the options to first consider how to do this good thing the best way.

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The opinions expressed by myself and other featured authors are their own and may not accurately reflect those of Lifeguard Wealth. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2018, Lifeguard Wealth