The “Down and Dirty” on 529 Plans

529 or qualified tuition plans are a great savings tool, but they are often misunderstood.  Few people know there are actually two types of plans that do two very different things.  The original 529 plan, rarely employed these days, is something called a prepaid tuition plan.  An adult (the account holder) purchases “units” or actual school credits on behalf of a student (the beneficiary) for a particular school, subset of schools or school in a specific state at current pricing in a hopes of “locking in” the cost of tuition and mandatory fees as a hedge against inflation.  It’s a nice idea, but if Susie or Johnnie wail that they “will absolutely die” if they can’t go to XYZ School that is not a part of the plan, you’re out of luck.  In most cases, you’ll recover your principal invested, but any return on that money can prove to be downright disappointing.  The much more popular 529 plan is the widely recognized education savings plan which allows the account holder to invest funds in mutual fund and exchange-traded fund (ETF) products and use the proceeds to pay for tuition, mandatory fees, room and board, computers, internet access and a range of necessary equipment to enable a student beneficiary with a disability to navigate her or his educational experience.  Not only are accredited colleges and university expenses eligible, but also the costs incurred at a trade school.  The education savings plans can also be used for up to 

$ 10,000 per year in K-12 tuition costs or up to $ 10,000 over the account’s lifetime to pay for student loan repayment.

Education savings plans, just like Roth IRAs, are a gift tied up with a big bow from the IRS.  After-tax funds are deposited into the accounts and grow tax-deferred (no annual 1099-DIV or 1099-INT forms) until the money is needed to pay qualifying educational expenses.  If the IRS dictates that the expenses, including those listed above, are qualifying, all the growth on the balances withdrawn is completely tax-free.  What a deal!  Let’s say Mom opens an account for Meaghan right after her birth with a deposit of $ 250.00 and sets up her plan to sweep $ 250.00 every month from her checking account into the 529 Plan (practically painless as she never sees the money).  Since Meaghan can only play with so many toys, Grandma and Grandpa and Uncle Eric funnel their birthday and Christmas gifts via check to the college savings plan.  Maybe Dad sticks a portion of his annual bonus in the account.  The power of compounding and the beauty of investment returns has the potential, over 18 years, to turn into a pretty sizeable nest egg that Meaghan can leverage to pay for that B.S. in Mechanical Engineering.  If you throw Great-Aunt Hilda, who is practicing intentional estate planning by awarding annual exclusion gifts into the mix, Meaghan’s account could benefit by a boost of up to $ 15,000 a year or whatever the current gift limit happens to be in a given year.

How does the account holder pick a 529 college savings plan?  You have lots of choices.  They come in all kinds of shapes and sizes and are offered by every state and the District of Columbia.  Some states offer their plan “in house” and some states partner with an investment company to offer the fund offerings of that particular company.  Some people think you have to invest in the plan of your state of residence or the plan of the state where your student wants to attend school.  Nothing could be further from the truth.  It’s possible for an account owner to live in Illinois, the beneficiary live in Iowa, the plan to be sponsored by Virginia and the ultimate destination of the school to be California.  According to savingforcollege.com, 30 states offer state income tax deductions or state tax credits if you invest in the plan in the state where you reside.  You might think that’s a “no-brainer”, but you need to dig deeper.  Please, please, please, do the math.  Make sure that you take into account fees, commissions, “loads” (fees charged by some mutual funds), and maintenance charges.  Be sure to check out at least 10 years of historical returns of the various funds you might choose.  Historical returns are no guarantee of future returns, but you can look at trends and get a feel for the risks and returns of the various options.  It might make sense to forego a tax credit from your state-sponsored plan if it has other fees or has overall returns that have always lagged that of another state’s plan you are considering.

Need assistance with college planning?  I’m here to help!  Please reach out to me at heidi@hhcinvestments.net or call me at 563-949-4705.

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