May 29 was National 529 College Savings Plan Day, yet most investors are unfamiliar with 529 Plans.
Saving for college may be one of the most important things you do for your children. There are multiple options for saving; however, the most common is a Section 529 College Savings plan.
The 529 Plan is specifically designed for college. The essence of the 529 Plan is that you put after-tax money into a dedicated account where it grows tax-free. Ultimately when you do pay that college tuition bill, you will owe nothing on the investment gains. 529 Plans are often state operated, and, as a perk, many states offer full or partial income tax deductions at the state level for contributions to their state’s plan. Ohio, for example, allows a $2,000 per beneficiary above the line exclusion from income with unlimited carry-forward of excess contributions. In other words, if you contribute $5,000 in 2017 for your son’s future college tuition, you can deduct $2,000 on your 2017 state tax return and carry over the remaining $3,000 to be applied in future tax years.
While there can be a wide range of investment options in a 529 Plan (the Ohio 529 Plan offers approximately 40 different choices), consideration should be given to time horizon. As your child gets closer to needing the funds for a tuition payment, a prudent investment decision would be to move the money into a less risky asset class such as a money market or a fixed income portfolio. International and/or U.S. equities are typically recommended when the period before entering college is longer as those asset classes historically offer greater returns accompanied with greater risks.
The 529 Plan also offers a great way to remove assets from your estate if that is a concern or desire. Without doing a deep estate primer, know that anyone can gift up to $14,000/year to anyone else without having to file a Form 709 ‘United States Gift Tax Return’ with the IRS. A 529 Plan also allows for a special provision called a 5-year election. That effectively allows you to gift 5 years’ worth of that $14,000 gift tax election all in one year – in other words, you could remove a total of $70,000 from your taxable estate in one year, assuming you made no other gifts. There is a catch though, and that is that you then need to live past that 5-year period, otherwise the IRS will reclaim the remaining balance back into your estate. This idea of allowing anyone to gift assets to a designated recipient coupled with the $70,000 5-year exemption amount makes the 529 Plan a very attractive option for grandparents wishing to pass on some inheritance to their grandkids while they are still alive.
Remember, the funds in a 529 Plan account can be used for tuition, fees, books, supplies and equipment, as well as room and board. The key is to use the money for a qualified educational expense; otherwise the distribution is subject to income tax on the earnings and an additional 10% federal tax penalty. When properly executed, a 529 Plan is one of the most effective college savings vehicles out there.
There are many things to consider before opening a 529 Plan. If you want to walk through this together, feel free to reach out to your Hengehold financial professional.