411 on 529 Plans

Americans have endured hard economic times in recent years, but this hasn't stopped millions of parents from pouring money into college savings plans. Did your parents prepare for your college education by saving money for you to attend? If so, they may have done so by setting up a college saving plan, known as a 529 Plan.

What is the 529 Plan?
So what exactly is a 529 Plan? It is named after IRS section 529 of the tax code and offers advantages to encourage people to save for college. The program was implemented in 1996. The American Recovery and Reinvestment Act of 2009 also expanded the features of the plan. The maximum amount that can be deposited into a single 529 Plan annually is $14,000. The minimum amount of deposit per month varies by state. However, it is typically very low with some states offering only $15 per month to be deposited. The goal of the program is to encourage people to have a plan of action to save for their children to go to college. Those 18 years fly by and too many parents are left wondering how they will pay for it all.

Finding the Right Plan
A common misconception is that you are limited by the state 529 Plan where you live. That isn’t true, you can seek out those that offer you the best incentives. However, you have to remember the state where you have the plan through is where your child will have to go to college. Just because you get your 529 Plan set up for a child is in a given state doesn’t mean he or she has to attend college in that state. There is plenty of flexibility within the programs. You aren’t going to be taking away the freedom of choice from your child if you set up such a plan when they are young.

Establishing a Beneficiary
Each 529 Plan must have a beneficiary assigned to it. This should be the individual who the money is to be used for college for. However, it is possible to change the beneficiary at any time. For example, the oldest child in your household may decide college isn’t right for them. You don’t want that money to go to waste so you can roll it over into the account for your next oldest child. There is no penalty for rolling over the funds and changing the beneficiary. Another scenario is you have a child with great scholarships so they don’t need the funds from the 529 Plan to attend college. Roll it over to another child you have in the household so they have more money towards their education. There are several tax benefits with this type of plan including:

 

  • The growth in a 529 account is tax-deferred payments made to the student from the plan are tax-exempt.
  • Some states offer tax deductions.
  • Assets in the plan are not subject to estate tax.
  • May still qualify for the Lifetime Learning Credit or American Opportunity Credit on the household tax return.
  • 529 plans come in two forms (a prepaid plan where you buy tuition credits at current tuition prices or a savings plan where you invest in mutual funds). 
  • What are Pre-paid Plans?
    In prepaid plans, you're essentially paying for tuition in advance. You're locking in at the current rates to protect you from inflation and tuition hikes in the future. Here are the some potential problems:

    Prepaid plans have a poor track record. A number have not been able to meet their promises and commitments. Some states have even canceled the plans.  The performance of 529 savings plans has been less than spectacular. In many cases they’ve turned out not to be the “sure thing” many parents thought they were getting.

    The Many Benefits of 529 Plans
    In addition to the mentioned tax benefits with 529 Plans, there are also plenty of other benefits for the household to think about. The account holder is always in control over the money in the account. This means if you put money in the account for your child or even a grandchild, you control it not them. The beneficiary can use the money for college but they don’t control it. There are very low required monthly payments into the plan. Some households opt to make an annual deposit instead of one each month. Others have the funds taken directly out of a checking or savings account each month in a given amount so they don’t forget to make it.

    You can always make a larger deposit at any time such as when you get a tax refund or when you get a bonus from work. While the maximum contribution per year is $14,000 you don’t have to deposit anywhere close to that amount. If you can do so that is terrific. If you were to deposit that much annually from the time the child is an infant, they would have about $252,000 to pay for college!

    If you didn’t start the 529 Plan early for your child you don’t have to stress about it. The law allows you to make a one time lump sum deposit of up to $70,000 single or $140,000 if you are married to the account. The funds are exempt from the Gift Tax of the IRS too. The funds can be used for all college related expenses at a participating accredited college in the USA. This includes:

     

  • Tuition
  • Fees
  • Room & Board
  • Books
  • Supplies
  • Understanding the Negative Elements of  529 Plans
    Here’s how it affects a student’s eligibility for need-based aid on the FAFSA. The more income and assets a family has, the less need-based financial aid the student will receive.  Years ago, a 529 used to count as a student asset. Today it’s considered a parent asset. It counts against you for financial aid. For many families, what it costs you in financial aid every year is greater than what the 529 earns.

    Therefore, the net result is a loss. Some parents try to set up the 529 in the grandparent’s name or another relative’s name, with the student as beneficiary. At first, the logic seems sound. When a dependent student completes a FAFSA, she has to report income and asset information. If a grandparent sets up the 529 in their name, however, it will never show up on the FAFSA and won't count against the family as an asset. That's all good until the next year rolls around. On the subsequent year's FAFSA, the student will have to report any distributions she received as a beneficiary of a 529 plan from a third party (such as grandparents). The student will have to report the money as untaxed income, which will hit her need-eligibility much harder than if the 529 Plan had been reported as a parental asset.

    If grandparents set up the 529 Plan, the student will eventually report it as untaxed income. It will be given far more weight as a source of income on your FAFSA, which means less financial aid eligibility. 
    If you've made the mistake of setting up the 529 in a third party's name, the good news is that you can always change it. If you've already completed the FAFSA, however, the change will not reflect until next year's FAFSA. According to Federal law, the information you report on the FAFSA must be true as of the day you complete the form.

    If you’re entering college and have a 529 plan to help out, just realize that these issues could present themselves during the financial aid process. Ideally, this type of plan can be a huge benefit if there is enough money in the account to pay for college. Small amounts though can prevent you from getting need based financial aid.