May 29th is National 529 College Savings Day. A 529 Plan is a state-sponsored college savings plan that can be used to sock away higher-education money on a tax-free basis.
Unfortunately, far too few Americans have 529 plans, perhaps because parents sometimes feeling overwhelmed by the ever-growing price tag of a higher education.
“The cost of college is a very daunting topic,” notes John Kenney, the CEO and head of Legg Mason Global Asset Allocation. Consequently, he adds, “there’s a lot of debt financing going on to finance college education.”
As Kenney points out, there is more than $1 trillion in student loan debt outstanding in the U.S., an amount that’s “bigger than auto loans, credit cards and home equity loans,” he says.
To avoid such massive debts, and to prevent derailing their own retirement plans, parents would be wise to create 529 plans for their children – including teenagers who will be off to college in a few years.
A 529 Plan “is like setting up an IRA for college education,” Kenney says, explaining that your savings in these accounts grow on a tax-advantaged basis. He should know. Kenney oversees the investment management and sales of the Scholars Choice 529 Program.
Here are four reasons to open a 529 Plan if a child or loved one will be attending college in the future.
1. A 529 Plan is Portable
In decades past, one of the reasons people didn’t like to invest money into college savings plans is because they didn’t like the idea of their kid being locked into attending school in one particular state or at one specific college or university.
But with 529 plans today, a student can attend any accredited college or university in the country – regardless of which state you purchase the 529 Plan. That’s because a 529 plan is portable and can essentially “travel” with you or your child wherever he or she chooses to attend school.
What this means, in effect, is that you can be a resident of, say, New York, Illinois, Oregon or Alabama, and you can put money into a 529 plan from any of these states – or any other state. Your child can later opt to go to any institution of higher education in the country and you could still use the money to pay for college costs.
2. A 529 Plan is Transferable
Assume that you’ve saved diligently in a 529 plan for years, and now all of a sudden your 18-year-old son says he doesn’t want to go to college. (Maybe he wants to “find” himself, or simply go backpacking through Costa Rica or France for an unknown time – hey it happens!)
You might think: Drats! I’ve saved all this money for nothing! Well, you can actually simply transfer the money into someone else’s name – and make it for the benefit of another child, or even yourself.
Again, as long as the funds are used for higher education costs, the money that accumulated over the years is tax free when withdrawn.
3. A 529 Plan Can Offer Juicy Tax Breaks
As mentioned, the money inside a 529 plan grows tax-free. When you’re ready to access your contributions and the accumulated earnings, “there are no federal taxes on money withdrawn to pay for college expenses,” Kenney says.
Additionally, some states offer separate state tax benefits for contributions made to a 529 plan. Tax benefits differ depending on the state in which you live. So check with a CPA or tax advisor about the rules in your particular state.
4. A 529 Plan Can Help With College Financial Aid
One quirk of the college financial aid system is that assets held in the parent’s name are assessed at a far lower rate than assets in a child’s name. This is good news when it comes to 529 plans.
Let’s assume you had $10,000 in a bank savings account in your kid’s name.
When it came time for college financial aid counselors to assess your Expected Family Contribution – or the amount of money you must pay toward college costs – that $10,000 in savings would be assessed at a 20% rate.
So in a nutshell, having those funds in your child’s names means you’d have to fork over $2,000 toward college expenses.
But let’s now assume that the $10,000 you saved was sitting in a 529 plan.
Since a 529 plan is held in the name of the donor – namely, you, the parent – and not in the student’s name, that money is assessed differently. Financial aid formulas dictate that you only have to pay, at most, 5.65% of the assets held in a parent’s name.
So the $10,000 invested in a 529 plan would mean your contribution toward college costs would cap out at $565. Compared to the $2,000 amount above, that’s a savings of $1,435 – making a 529 plan an even sweeter deal.
With all these benefits, what are you waiting for?
Procrastinating will only lead to a big pile of regret down the road when you look at the sticker price of college and think: “how in the world can we afford this?”
Avoid that fate, in part, by saving early and making sure you open a 529 plan for your child right away!