It’s time to take another look at 529 College Savings plans. The recent tax bill creates some changes in the uses of 529 college savings plan – and may even make them more attractive from a tax point of view.
You cannot deduct 529 contributions on your Federal tax return. But, with state income taxes no longer deductible (over $10,000) on federal tax returns, every bit of state taxes you can save becomes more valuable. And many states allow residents a limited deduction (or credit) against state income taxes for contributions to state-run 529 plans.
But even if you don’t qualify for a state income tax deduction, a 529 plan is still the best way to save for college because:
- All growth of investments inside a 529 plan is withdrawn tax-free for approved college expenses.
- The money can be used for any accredited school, in any state – no matter which state plan you use to invest.
- The money can be transferred between members of the same family, so if a sibling gets a scholarship, another family member can use the 529 account.
- Assets in a 529 plan count far less against the family in the financial aid formulas than student assets. ( 529 plans held by grandparents do not count at all, but require some interesting strategies at withdrawal time.)
- 529 Plan assets can now be used to pay for primary and high school private school tuition expenses.
529 Investment Plans and Prepaid Tuition Plans
The section of the law that created this savings program allows for two different types of 529 plans: investment plans and prepaid tuition plans. Of the nearly $300 billion invested in 529 plans, about 90 percent is in investment plans, where you choose from a limited number of mutual funds and the eventual results depend on market performance and your investment choices. Most offer “age-based” funds that promise to become more conservative as your child gets closer to needing the money for college.
State prepaid tuition plans let you purchase future tuition at a discount, with a promise of fully paid semesters when your child enters college. Many prepaid tuition plans have run into funding problems as tuition hikes outpaced investment returns. Further, the fine print reveals that in some states the “promise” is not a state guarantee. Tread carefully, unless your state has a sound budget and growing tax base.
Most investment-type plans allow you to start with a small amount, and make regular automatic contributions from your checking or savings account. Friends and family can also contribute. In fact, very generous (and wealthy) grandparents might take advantage of the provision that allows a one-time contribution of 5x the annual gift tax exemption ($15,000 in 2018). So each grandparent could gift a total of $75,000 to each grandchild – a simple way to distribute an estate!
Money contributed but not needed, or needed for a hardship situation, can be withdrawn by paying ordinary income taxes on the gains and a 10 percent penalty.
The tax bill gives new opportunity to distribute 529 accounts without penalty. The money can now be transferred (up to $15,000 per year) to 529 ABLE accounts, which are accounts for people with disabilities. The money in Able accounts (up to a limit of $100,000) continues to grow tax free, and the balance in the account does not impact Medicaid eligibility or other state aid programs.
The best way to get started investigating 529 plans is at www.SavingforCollege.com. There you can compare plans, for performance and fees. You can even link directly from this site to the application forms of the various plans. Your own state’s plan may have a tax advantage noted above, but it’s worth comparing to other state plans since fees can be a drag over the long run of this investment. You don’t really need a financial a financial advisor to get started with any of these plans. And the plans sold by advisors may be more costly.
Once you’ve accumulated money in a 529 plan, there are another set of choices in taking distributions while maximizing financial aid. But that’s a “problem” for the future. The real challenge is getting started now to arrive at that point. And that’s The Savage Truth.