Introduction to 529 Plans for Higher Education Savings

If you have kids or grandkids and have ever thought about saving for their education then you should read this.

Even if you have thought about going back to school someday to obtain a masters or perhaps even complete a bachelor’s degree you never finished, some of the investment vehicles mentioned in this article can help you better understand your options for education savings.

While this article will focus mainly on 529 plans, I will quickly touch on two other types of accounts and why they may or may not be useful to you.

Uniform Gift to Minors Act (UGMA)/ Uniform Transfers to Minors Act (UTMA) accounts - this account consists of an outright gift to a child. Once the money is contributed to that account, it is no longer yours. You may act as the guardian for the account until the child reaches age 18. After that, the money is technically theirs to be spent how they wish. We will not dive into the details of various usages of these accounts, but one thing is for sure - if you want to see to it that your child uses the money for some productive purpose, teach them good money management skills early in life.

Coverdell Accounts - this type of account is much more similar to a 529 than UGMA/UTMA accounts. You can save up to $2,000 per child each year and the money can be used not just for higher education (i.e. college) but also for K-12 education as well. An account like this could be useful if you intend to send your child to a private high school and you have many years to let this money remain invested. A downside is of course $2,000 per year is really not much. Also, depending on how much income you make, you may be phased out of using this type of account anyway.

On to 529 Plans – The most likely choice for your higher education savings needs.

529 Plans are an excellent way to save for higher education expenses.

The cost of education has been steadily rising for several decades now and it is unlikely that higher education will become less expensive in the future.

Unless you want your loved one to rely on student loans or working full-time while in school, it is wise to consider stashing at least some amount in a 529 plan well before a child or grandchild goes to college so that they can reap the rewards of a debt-free (or at least less debt laden) higher learning experience.

The great news is that even if you end up with a child that does not need the money, you can always transfer the money to another family member inside another 529 account.

State Sponsored 529 Plans

Most states have a state sponsored 529 plan. If you live in the state of Louisiana, there is a wonderful program called LA START. You can learn more here. If you are not from Louisiana or are interested in checking out programs available in other states, visit http://www.savingforcollege.com/ to do additional research.

Some of the benefits of a 529 plan with LA Start include:

  • Investment options through The Vanguard Group
  • There is no cost to be enrolled in LA START except for an investment management cost if you select one of the investment options available with Vanguard
  • Earnings Enhancement Credit - if you qualify for these credits you may receive a match on the money that you contribute to the 529 plan throughout the course of the year
  • Contributions up to a certain amount may be deducted on state income taxes

To review additional features and a general overview of the LA START plan click here

Below are some action steps that you can take once you have determined that a 529 Plan is right for you.

Action Step #1: Set up Your 529 Account

Set up your 529 plan with your state or some other state if you have found one you might like better that allows non-residents to participate. If you need to do more research on the plans in each state we have found that http://www.savingforcollege.com/ is a great resource for doing so.

Action Step #2: Determine how much you want to save.

Only you will know your personal budget and the amount of money you may be able to set aside. Go ahead and calculate that amount. If you need help you can use a 529 calculator like the one available through http://www.savingforcollege.com/college-savings-calculator/.

Keep in mind that in order to avoid using any of your estate/gift tax lifetime estate exemption you can contribute $14,000 per year (per beneficiary) or as much as $70,000 in a single year (and the IRS will spread this amount over the next 5 years...$14,000 x 5 = $70,000). If you are married, then you and your spouse can elect gift-splitting, which would allow these numbers to double to $28,000 per year or $140,000 in a single year that would be spread over the next 5 years without gift tax consequences. The more money you save sooner, the more years the money has the opportunity to grow, depending on how it's invested.

What you save to a 529 plan is not federally tax deductible, but remember, the money you contribute may grow in value due to how it's invested. These earnings as well as your initial contribution can be used for higher learning expenses with no taxes or penalties.

Action Step #3: Pick Suitable Investments.

The whole point of the money being in a 529 Plan is the opportunity to grow your contributions over time and use this (hopefully higher amount) to pay for education related expenses with no tax consequences. Make sure the investment that you use is suitable for your risk tolerance and time horizon.

Action Step #4: Remain Confident & Keep Saving

The hard work is done. The account is set up and hopefully you have set up a direct deposit of some amount each month to go into this account, even if it's very small. Building the habit is often the hard part.

Consider using one-time events each year like a tax refund, or unexpected bonus, or a raise to provide the additional money to dedicate to this savings goal. The longer you have to save, the better your chances in growing your account are likely to be.

Action Step #5: Spend the Money

You have finally reached this point of your little one not being so little anymore. It's time for school and you get to realize the benefit of your years of diligent savings.

You can pay for qualifying expenses by either paying directly to the school (when available) or simply reimbursing yourself for those expenses. It is important to maintain good records of your expenses like receipts and invoices.

Below are some of the qualifying expenses for 529 Plans:

  • Tuition and fees to the institution.
  • Room and board but only to the maximum that is charged by the university. In this case, if your child lives off campus, you can still take money from the 529 plan for rent, but it cannot exceed the allowance for room and board included in the school's cost of attendance for federal financial aid calculations. This will be different for each school.
  •  Books and supplies but only to the degree they are required for the course being taken.

Bottom Line…

If you know you want to save for a loved one's higher learning (or even your own) then you should probably open a 529 Plan. Most plans have a very small minimum savings requirement each month.

Save early and save often.

And if down the road you realize that you need some of the money in the plan for unforeseen non-education expenses for you or for your family? Well, you would– simply pay taxes on any earnings and a 10% penalty on the withdrawal amount.

But be realistic. Don't save too aggressively to the point of setting yourself up for failure. You don't have to be wealthy to use these types of accounts. We encourage all of our clients to use such accounts unless they have other means of paying for college or simply cannot afford it at the time.

Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.

Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing. Investing involves risks including possible loss of principal. 

If you have questions about 529 Plan options and what might be appropriate for you, let us know about your questions and we would be happy to provide resources to assist you in making a more informed decision.