Thanks to the Pension Protection Act, the 529 plan looks like it is here to stay. These plans were initially slated to end in 2010, but that’s no longer the case and they are here to stay. A 529 plan is clearly recognized as a college education savings plan, but the benefits don’t stop there. For those unfamiliar with how a 529 plan works, the general premise is similar to that of a Roth IRA for education. 529 plans generally allow after-tax contributions which are then allowed to grow not only tax-deferred, but federally tax free provided the distribution is for qualified education expenses. The plans are different among each state and run by different investment companies so the specific investment choices do vary.
While it is easy to see how setting one of these up for your child may be a great way to start saving for college, there are many benefits that don’t necessarily benefit the child directly. One of the best benefits offered by most plans is the ability to change the 529 plan beneficiaries. Let’s say you have two children–what this means is that if you set up the plan for child A and they decide not to go to college, you can rename child B as beneficiary. This can continue on for later generations as well. If none children head to college you can usually even name yourself or your spouse. Looking even further, you can let the account continue to grow for even more years then naming your grandchildren. This is one of the features often misunderstood and one reason people may feel reluctant to start a 529 plan since they believe if their child doesn’t go to college they will be stuck paying a penalty.
Changing, or naming the beneficiary to an adult or yourself is a great feature because a growing trend is for people to seek further education as they age. Some people find the need to get that graduate degree at 40 in order to advance their career, others want to retire from their day job and become a professor at their alma mater, and so on. You don’t have to strictly use 529 proceeds to finance your child’s education. You can use it for yourself in the future as well, or even pass it on to grandchildren.
Tax Breaks on Contributions
As more states get on board with 529 plans the tax breaks are becoming even more widespread. These are tax breaks on contributions, not just the tax benefits of the investments. For example, in Indiana you can receive a 20% tax credit on the first $5,000 that is contributed to an in-state 529 plan. That means you have a maximum $1,000 tax credit you can obtain each year by contributing to the plan. Since it’s a credit and not a deduction, that’s money going directly into your pocket. Most other plans also provide some sort of tax breaks for in-state contributions as well.
But what happens if your kids never go to college or you never seek a further education yourself? All is not lost because the 529 can have significant tax benefits upon your death as well. Assets held in a 529 plan are generally not subject to estate tax. That means any contributions made to the program, in fact, your entire account value if you are the only one funding the account, is not included in your estate. Sure, there are more straightforward estate planning vehicles, but it’s something to keep in mind.
A Few Drawbacks
While the number of benefits are many, it does not come without some words of caution. First is that if you need to access the money, unlike an IRA, even if you are retired and over 59 1/2 the gains from the distribution will be taxed and assessed a 10% penalty if used for a non-qualified expense. Second is that every plan is different. You generally have to participate in your own state’s plan in order to receive the tax benefits on contributions, but it is possible that your state does not have the best investment options when compared to another state. Also, every plan has their own set of restrictions and investment choices. For example, even though I live in Michigan, we contribute to the Virginia 529 plan because the lower expenses outweigh the Michigan plan and tax deduction.
Finally, you need to put your priorities in order when it comes to saving for multiple goals such as saving for college and retirement. I feel that younger adults should focus on adequately funding their retirement accounts first, and if that is on track to then fund other goals such as college savings. When push comes to shove you can borrow money to obtain an education. When you retire, what you’ve saved is what you have to work with. There are no retirement loans available at the bank or from the government. When the time is right to open a 529 for your children or yourself make sure to take the time to explore all of the options available to you in order to make sure the plan will work for your needs.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
There are universities abroad that are accredited here in the U.S. Can my beneficiary use that money to attend accredited universities overseas? Where can I find more info on that?
I have heard of upromise but not the other ones. I will have to check them out, thanks for the heads up on those.
I have started a 529 plan for my kids - they are both 14 months old now. I hope to have enough saved by the time they reach 18 and head to college. have you heard of the services that put money into your 529 from shopping online like upromse? little grad? baby mint?
Thanks for the outstanding start on 529s. I had been thinking about them for some time. It's a little too early for me to plan kids at this stage and I think I'm more or less done with school, so it's good to know there are other reasons to look into it. I will have to investigate further.
I opened a 529 when I started studying for my Masters several years ago and contributed to it regularly. As it turns out, my employer covered all the costs of my degree so I didn't have to dip into it.
Thanks to the ability of the 529 to change beneficiaries, I plan on converting it over to my new son to give him a head start on college savings!
I guess the moral of the story is if you plan on having kids someday, open a 529 and start contributing to it today! Of course, after you fund your retirement account, as we know, you can't get a grant for retirement :(