What the heck is a 529 plan? Here you go…

August 28, 2020  | By Kevin Smith

What is a 529 plan?

A 529 is a tax-advantaged education savings account that allows money to be saved and invested for a beneficiary, typically your child or grandchild. The earnings grow on a tax-deferred basis, and funds can be withdrawn tax-free to cover the cost of qualifying education expenses. The most common qualified education expenses include tuition, room and board, and books. Starting this year (2020), 529 funds can be used to pay up to $10,000 per year of K-12 private school tuition.

The tax benefits grow at a compounding rate, so the longer you are invested in the 529 plan, the greater the tax benefit tends to be.

Each state hosts one or more 529 plans. There may be income tax benefits from using your state’s plan if your state has an income tax. If your state does not have an income tax, you should consider all of the available plans. The main characteristics we look at are 1) administrative fees, 2) investment choices, and 3) ease of use (usually means website usability and customer service). As of the publishing of this blog, we prefer the Utah-based 529 www.my529.org.

The investment options are a lot like those in a 401k plan. You are limited to a menu of investments that are typically mutual funds. You can choose a pre-packaged age-based portfolio that starts out with a high level of risk and becomes more conservative as your child approaches college age. I find those to be a bit too conservative and prefer to create a custom portfolio out of the individual mutual fund options, but the age-based portfolio will likely serve you well.

If you have more than one child you may want to open up an account for each of them to keep track of how much you have allocated, and it tends to make it easier to manage equitable distributions, but you can set up one account and adjust he beneficiaries as you go.

Does a 529 plan restrict my child’s college choices?

Probably not. Most schools are covered. Look up any institution’s eligibility here.

There are 2 types of 529 plans. A 529 prepaid tuition plan and a 529 Savings plan. Prepaid tuition plan benefits are generally designed to be used at in-state public universities and community colleges but there are exceptions to that too. Prepaid tuition plans are simple and ‘set it and forget it’ and may be more suitable for the risk averse, but there is likely more growth potential of your investment dollars in a 529 Savings Plan because you can build a custom portfolio of stocks and bonds.

How much should I add to the 529 plan each month?

It depends. To fully fund a four year public in-state college experience usually requires at least $500/month starting at a very young age. This assumes college costs increase at 5% per year and your investment return is 7% or 8% on average. The amount of funding you should target depends on how you want to help your kids, your overall situation and financial plans.

There is a maximum amount of funding for 529 plans, but it is so high that people rarely need to worry about it.

How will a 529 affect financial aid?

The 529 is considered an asset of the parent, not the child, so the federal aid application will consider 5.6% of the 529s balance toward funding per college year. Accounts held by the student are applied at 35%, so in general the 529 helps improve the chances of financial aid compared to other account types. It gets more complicated than this, but that’s a start.

What if my kids gets a scholarship?

You can take out the exact amount of the scholarship without penalty, but you will have to pay taxes on the investment earnings associated with the withdrawal.

What happens to the 529 funds we don’t use for college? 

You can change the beneficiary on your 529 plan at any time, so you can reassign the funds to another child or family member. You can withdraw 529 funds for any reason, but if they are not used specifically for college, you have to pay taxes and a 10% penalty on the earnings (not the money you invested, just the growth of that money). If you have more than one child, the odds increase that one of them may not go to a traditional college, so we usually encourage a combination of 529 plans and unrestricted investments to reduce the risk of being stuck with excess 529 funds.

Posted in: College
Kevin X. Smith, CFA
512.467.2003   |  [email protected]

Kevin is on a mission to find better ways to explain complex concepts in increasingly simple and meaningful demonstrations. Everyone has a different level of interest in learning about investing – ranging from “I just want to know that I…Read More




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