Have you ever weighed up the return on investment that comes with having a college degree? Or why saving for a child’s college education is among the biggest financial stressors facing American parents?
If you sit down to crunch the numbers, it’s clear that it all comes down to future possibilities. Holding an associate degree elevates annual earnings well above those that could be achieved with just a high school diploma or some, unfinished college attendance in hand.
By the early 30s, an age considered the peak when it comes to career earnings, a bachelor’s graduate might expect a $68,000 yearly salary (2018 figures), compared with $48,000 for associate degree graduates. High school graduates, meanwhile, would be earning on average around $35,000 a year.
Over an entire career, a bachelor’s degree graduate is set to out-earn a high school graduate by more than double.
This clearly illustrates why saving for college is a serious priority for parents keen to give their children a leg up in a fast-paced and competitive world.
While many families choose to save for college expenses using a savings or checking account, or these days even through cryptocurrency options, the handy 529 plan is often unappreciated, misunderstood and underused.
What is a 529 Plan?
Only 30% of millennials (those aged 25 to 40) in the US are familiar with the 529 college saving plan, also known as the Qualified Tuition Program. This is just slightly lower than the collective number of Americans (36%) who understand how this tax-advantage educational saving vehicle works.
While there are ins and outs to consider, the good news is that it’s not rocket science. Each year an individual can put up to $15,000 (2021 figures) into a state-sponsored 529 plan for use by an earmarked beneficiary. That’s without having to pay gift taxes.
The 529 plan works by enabling savings to grow tax free in the account and does not usually require the beneficiary to declare the earnings as part of federal income.
The funds are not taxed on withdrawal when the proceeds are used for educational purposes, including college, private schooling and apprenticeships, even kindergarten.
How Do 529 Plans Work In Your State?
Since 529 plans are administered independently by each state, the tax benefits differ and should be carefully discussed with your wealth professional or researched to ensure you go into the plan with your eyes open.
Some states, such as Arizona and Minnesota, offer state tax deductions for contributing to 529 plans, while others, like Texas and California, do not. Also, pay attention to minimum contribution amounts and enrollment fees.
It is possible to shop around and take out a plan in another state, so spending some time looking at the pros and cons is a great idea. The College Savings Plan Network makes this simple by offering an online tool to compare plans across states.
Here’s What Our Clients Are Asking:
When it comes to fine print, there are more than a few considerations of which you should be aware when deciding if a 529 plan is for you. Here are just a handful of the questions I’m often asked:
Does having a 529 impact financial aid eligibility?
Generally not, since most colleges use the Free Application for Federal Student Aid (FAFSA) to calculate each student’s Expected Family Contribution and this only takes into account a fraction of parental assets. It’s worth noting that grandparent-owned 529 plans are not reported using FAFSA.
Can I use 529 money to pay off student loans?
It is possible to use 529 money to pay off up to $10 000 in qualified student loans, but there are conditions based on the plan you choose. In addition, if your child wins a college scholarship, it is possible to withdraw the equivalent of the scholarship amount from the 529 without incurring a 10% penalty – although tax would be payable on the gains.
Can I use the grandparent ‘loophole’ for wealth transfer?
Absolutely! A 529 has the advantage of tax-free withdrawals, if they are used for qualifying educational expenses, and can also be a handy estate-planning tool. Since grandparents can take out 529 plans, and even change beneficiaries and owners within the family at will, it is possible to use these vehicles to transfer wealth across generations.
Since there is no limit to the number of 529 plans a person can hold, grandparents can open one account per grandchild and contribute $15,000 annually per beneficiary without triggering gift taxes.
What is the difference between a 529 savings plan and a pre-paid plan?
Choosing a 529 savings or prepaid plan largely comes down to your appetite for risk. A prepaid tuition plan will offer you growth below inflation, but buying credits at today’s rate secures your child’s place at a state institution in the future. One concern is if you move states, since these plans are usually state specific.
Savings plans are more flexible in terms of transferring ownership, when you can take out the plan and enables you to also spend the funds on room and board. Plus, a 529 saving plan has the potential to grow at a faster rate, depending on the markets.
What Else Do You Need to Consider?
There are times when a 529 plan is not the best use of your available resources. For instance, if you don’t have an emergency fund in place, if you haven’t made provisions for your retirement or ensured you have adequate life or disability insurance cover. Also, if you are paying off debt, you might also be advised to clear that slate first before you start saving for your child’s college education.
Choosing the right 529 plan and using it to its optimal can be daunting. Discussing the wealth transfer potential and the various choices on the table can help alleviate some of the uncertainty, so if you’d like some professional guidance, please do get in touch.
Together we can find the right 529 plan for your needs and ensure that all the advantages of this college saving option are maximized to help you secure your child’s best future. So schedule an appointment to talk through the options, and let’s get you on the right savings track.