529 College Savings Plan Basics : The ABC’s

We discussed in a previous post about the 529 college savings plan basics. I’d like to talk more about the basic in this one so we even have an even more of a deeper understanding as to how they can help your child pay for college.

The Time is Now to Start with a 529 College Savings Plan

Let’s paint a quick scenario shall we? Your child is getting into high school and/or they are starting to get their acceptance letters into hopefully the college of their choosing. 

There are types of reactions that will occur financially for the parents:

  1. “YAY we saved and although college is super expensive, it won’t be that much of a burden on us.”
  2. “Uh Oh, we never saved properly and now it may be too late. Looks like we will have to hope for financial aid and student loans to cover the tuition costs.”

Now a few things people don’t tell you and that is, kids grow super-fast, college will only continue to get more expensive, and the time to start planning for this was yesterday.

Only 21% of Families are Using 529 College Savings Plans

Per Sallie Mae’s most recent report: How America Pays for College, only 21% of families are using 529 college savings plan as a source to pay for tuition. That’s a super low percentage if you ask me. The question is, why is that low?

The nuances of the 529 college savings plan is pretty simple.

So then it has to come down to either:

  1. Lack of knowledge and information for families (they may know more about the 529 counterpart: Prepaid Tuition Plans).
  2. Families feel that they won’t be able to contribute to it (aka affordability).

Advantages of a 529 Savings Account

529 savings plan offer great flexibility and tax advantages. You can take the money from the 529 plan to pay for educational expenses at the elementary, high-school, and collegiate level.

Again in our previous post we discussed the benefits of the 529 college savings plan. But let’s take a little bit of a deeper dive into the advantages.

Less Impact on Financial Aid

For the families that are aware and knowledgeable on financial aid, they may think that savings for college will hurt their chances at receiving financial aid.

The fact is that the 529 college savings plan (and their assets) are considered parental assets. Meaning they are factored into the federal financial aid formulas at a maximum rate of about 506%.

So then only up to 5.6% of the 529 assets are then included in that all important expected family contribution (EFC) number.  

Good news is that it’s lower than the potential 20% rate that ends up occurring if families were to possess a UGMA/UTMA custodial account.

Fewer Restrictions

The 529 college savings plan does have fewer restrictions than other savings plans out there. There are no income or age restrictions which is nice and the upper limit which varies by state on annual contributions is about $300,000 (again varying by state).

Anyone can also up a 529 college savings plan. This includes:

  • Parents
  • Grandparents
  • Other relatives and friends

Control and Choose

With a 529 college savings plan, the account owner (not the child) calls the shots on how and when to spend the money contributed. This control allows the parents to ensure the child doesn’t spend the fund on anything other than college.

Your child may not choose to go to college or in an amazing scenario gets a scholarship. In this case the account owner can transfer the money to another named beneficiary.

Each 529 savings plan has its own range of investment options that may include the following types of portfolios:

  • Age-based strategies
  • Conservative
  • Moderate
  • Aggressive
  • Mix to build your own portfolio

The key is to first define the investment objective. It’s vital to think strategically about how you want to invest your savings. More aggressive portfolios can put you at more of a risk for losses. On the other hand, being conservative can also be risky because your money might not grow enough.

Potential 529 Tax Benefits

Oh those tax benefits are just so enticing when it comes to the 529 college savings plan. If used to pay for qualified education expenses, then no federal income taxes are owned on the distributions. This includes the earnings and this benefit alone is a reason to look into a 529 plan.

Nevertheless, there are other tax benefits as well.

Estate planning benefits

Contributions made the 529 savings plan are what is known as “completed gifts” for estate tax purposes. They then come out of your taxable estate even though the account is in your control.

Lump sum benefits

One can give $75,000 per beneficiary in a single year and it gets treated as if you were giving that lump sum amount over a 5-year period. This allows an investor to potentially make a large 529 plan contribution without eating into the lifetime gift-tax exclusion.

State tax advantages

States can also add their own advantages to the 529 plans. Some states exempt qualified withdrawals from income tax or offer an annual tax deduction for the contributions.

State Specific 529 College Savings Plan

You are not limited to your home states 529 college savings plan. Remember, I live in Florida and have New York 529 college savings plan. Some states offer tax benefits and others don’t. Some states limit the tax benefit to only the in-state plans.

23 States where you can pick any 529 college savings plan

There are 23 states in which if you live in them you can choose any 529 plan from another state.

They are:

  • Alaska
  • Arizona
  • California
  • Delaware
  • Florida
  • Hawaii
  • Kansas
  • Kentucky
  • Maine
  • Massachusetts
  • Minnesota
  • Missouri
  • Montana
  • Nevada
  • New Hampshire
  • New Jersey
  • North Carolina
  • Pennsylvania
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

11 States that limit contributions to a home state sponsored plan

There are 11 states including Washington D.C. that will limit your benefit of contributing to only a plan sponsored by your home state.

Those states are:

  • Connecticut
  • Washington D.C. (after two years)
  • Louisiana
  • Maryland
  • Michigan
  • Mississippi
  • North Dakota
  • Oklahoma (after one year)
  • Oregon
  • South Carolina
  • Vermont
  • West Virginia

The Remaining Sates

If you happen to reside in one of the remaining states then your state offers a state income tax benefit for contributing to your 529 college savings plan. It limits the tax benefits to only its own plans and if you move the money out then the state will recapture the previous tax benefits.

Lowest Cost 529 College Savings Plans

Here are the 529 savings plans that feature the lowest cost. None of the plans below charge an annual account fee by default.

Highest Cost 529 College Savings Plans

Now let’s look at the highest cost 529 college savings plans:

Power of Compounding

The power of compounding can create a windfall for those investors out there. With the 529 plans tax-free compounding, the longer your hold the money in the account the more it has time to grow. That is why that even if you do not have a lot of disposable income, small and consistent contributions over a long period of time helps tremendously.

Automatic Contributions

Another benefit to the 529 college savings plan is that most of plans will allow the account owners to link their 529 plan to a check or savings account to schedule the automatic contributions. So the term “set it and forget it” comes into to play. If something changes and you aren’t able to make those deposits then you can just change the settings in your accounts.

The Initial Contribution

In my personal situation, my wife and I saved for a while in preparation for making a sizable initial contribution to the 529 so our children had a head start. Remember there is no minimum to open or contribute to the account, but that initial contribution is essential.

Ask for Gifts

Each year for your child’s birthday when family members are asking you what to get, try suggesting a modest gift that you can then use for their 529 plan.

You can direct them to one of the two gifting websites below:

Direct 529 Plan or Advisor 529 Plan

Another thing you want to decide early on is if you are going to enroll in the 529 college plan yourself or get assistance from an advisor. It’s a daunting task and it can get confusing even for families that have sound financial minds. I know the help of my advisor has made the process so much easier and their advice that they give is stellar. So if you are like most of us that yearn for that advice and prefer to have that someone to reply on, then going with an advisor is probably the best bet.

Keep in mind that in my situation, we actually didn’t start off with an advisor but then we eventually moved the account over to one.

Simplifying the 529

Most will (and rightfully so) get overwhelmed with the whole “saving for college.” Most families will look at a college degree as an expense such as your water bill. However, maybe it needs to be looked at as an investment.

Those with a bachelor’s degree have a median weekly earnings of 60% higher than those with a high school diploma alone per the Bureau of Labor Statistics. So they earn more and their unemployment rate was half. So with that said, the shift should be to thinking it’s an investment.

But how do we make it manageable so that even if we are on a budget we can contribute? I think it’s best to make the process simple and then eventually we can think about ways to grow the 529 savings plan. The important thing is to know that it’s possible and that anyone can open one up.

529 College Savings Action Plan

  1. Research lowest cost 529 plans
  2. Pay attention to annual fees and contributions minimums
  3. Decide if you want to enroll  in the plan yourself or go with an advisor
  4. Select the state specific plan
  5. Determine an initial contribution amount
  6. Make small, manageable, and consistent payments
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