Last week I told you about 3 Things More Important than Saving for College. If you have all three of those things taken care of, congratulations! Today we will talk about the most popular college savings vehicle, the 529 plan.
First, and this is very important…
You do not have to use a 529 plan to save for college.
A plain old savings account or brokerage account will do just fine. The benefits are:
- You keep the money in your own name.
- If you need the money for something else, you can get to it without penalty.
- Simple and inexpensive.
Don’t fall for all the marketing and peer pressure to have a IRS dedicated college savings plan unless you are sure the ‘benefits’ are really worth it.
What are the benefits of 529 plans?
- Tax – Once you put money in the plan, it grows tax free. You do NOT get a tax deduction for putting money in the plan. However, it is a savings and simplifies your tax returns for the account to grow tax free (no 1099). State tax benefits differ by state, some even include a state tax deduction, so know the rules for your specific state. Also, once you start withdrawing you must keep records of qualified expenses, so your tax return does get more complicated at that time. Keep in mind there may be other tax programs that result in better savings than tax free growth.
- Control – You are the owner of the account, always. That means it doesn’t fall into the hands of your kids when they reach a certain age to spend however they like. You also can change the beneficiary to a family member, if for instance one of your kids doesn’t go to college.
- Any school – Unlike some state plans or private school plans, the funds from a 529 can be used to pay for post-secondary education at any qualifying institution. Funds can be used for tuition, fees, books, as well as room and board.
- Planned giving – discussed next.
When do we recommend a 529 plan?
The ownership structure and tax treatment are great for planned giving. A grandparent or other family member or friend may gift up to 5 years of annual exclusion gifts ($14,000 per year in 2014 and 2015) at one time. That means grandma could move $70,000 out of her estate all at once to pay for Jr.’s future education expenses.
Some people save better when it happens automatically and is then hard to get to. They don’t miss the money if they never see it in their checking account. If this applies to you, and you have the rest of your financial house in order, then set up a payroll deduction or automatic draft each month as a way to put the savings on auto-pilot.
Watch out for 529 plan fees
Know what you are paying. Each plan has a different fee structure to the plan and also within the investments offered. Understand these fees and evaluate if they are reasonable or excessive. The tax benefit can easily be eaten up by excessive fees charged by some plans.
Don’t overfund a 529 plan
If you overfund a plan, you will end up giving it away or paying penalty. If you didn’t save enough in the plan, you can always use other savings. So don’t assume and save for all 4 of your kids to go to an expensive private school. Save for something short of that, and if they all end up at Yale and you can afford to pay for it all, then you can use some of your other savings. Most likely they won’t ALL choose that route.
Resources on saving for college