As a parent or guardian, it’s never too early to start thinking of your child’s future, particularly their education:
The tuition costs for college and universities have steadily increased over the years, according to the National Centre for Education Statistics (NCES) of the U.S. DoE. Compared to the 2008-09 academic year, the fees at 4-year private institutions were 40% higher in 2018-19, reaching $44,662 from $31,232. Similarly, the fees at 4-year public institutions increased by 44% during the same period, reaching $20,598 from $14,212.
If we look at the change in the past 20 years (2000-01 to 2018-19), there was an increase of nearly 240% at public institutions and over 200% at private institutions. In terms of affordability, college costs inflate at about double the rate of inflation, according to a Forbes report.
These stats make it clear that when it comes to affording a college education, the time to plan is now.
THE 529 PLAN
Authorized by Section 529 of the Internal Revenue Code, 529 plans are tax-advantaged accounts for parents and guardians looking to cover their child’s future educational expenses. The legal name of the plans is “qualified tuition plans,” according to the SEC. You can use the funds for post-secondary as well as K-12 education.
While the 529 plan is named after a portion of the federal tax code, it’s the States and educational institutions that sponsor it. The incentives and benefits vary from State to State, but all 50 States and the District of Columbia sponsor at least one 529 plan, according to the SEC.
CONTRIBUTING TO THE 529 PLAN
The savers typically use after-tax money to invest in mutual funds. One of the factors influencing investments is when you’ll need the money. Portfolios that consider the target date (college enrollment), or the child’s age, go for less volatile investments when that date is near. It’s important to remember that – like other investments, such as 401(k)s – the possibility of a loss is very much there with a 529 plan as well.
Contribution to the fund is capped at the annual exclusion amount – the amount you can transfer to another person as a gift without incurring a gift tax. For 2021, the annual exclusion is $15,000 per recipient, according to the IRS.
The lifetime exclusion per donor is $11,700,000 in 2021. This means that if you gift over $15k to your child, you won’t necessarily have to pay, provided you’re still under the lifetime limit. Since the gift limit is per recipient, there’s the possibility to give annual gifts to multiple beneficiaries at once. In terms of minimums, the requirements are usually none or low. In some cases, you can open a savings account with just $1 and contribute as little as you like.
The fees for the saving plans may include application fees, maintenance, and asset management costs, etc. The state sponsor and plan manager charge these fees. Program manager refers to the mutual fund company or other financial services firm handling the investments. If you buy from a broker, you usually pay some additional fees. To avoid these fees, you can look for plans sold directly by states.
Many States offer additional incentives, such as a tax deduction, with their plan. For example, New York offers a deduction, along with zero tax for their Direct Plan and tax-free withdrawals. As a NY resident, you may deduct up to $5,000 of your contributions. The amount doubles if you’re filing jointly with your spouse.
Most 529 plans aren’t restricted to residents of the state. Continuing with the NY Direct Plan example, you can apply if you’re a U.S. citizen or resident alien with a verified permanent address and a Social Security or Tax ID. Considering these facts, you shouldn’t settle for the plan offered by your State. Instead, do your due diligence to identify the best options.
TYPES OF 529 PLANS
There are two main types of 529 plans: education savings plans and prepaid tuition plans. Here are the features of these options:
Education Savings Plans
Education Savings Plans are the more prevalent option. These accounts offer tax-deferred growth and tax-free use of the money, provided you use it for qualified higher education expenses – “tuition; room and board; mandatory fees; and, books, computers, and software (if required),” describes the SEC. Education savings plans are administered by State governments.
Direct-Sold Saving Programs
With this option, you’ll be purchasing directly from the plan manager. States approve and monitor the plans. The benefit of selecting a direct sold plan is that there will be no sales charges.
Washington’s DreamAhead College Investment Plan requires a contribution of $25 (initial) and $5 (per portfolio) and has a cap of $500k. The Texas College Savings account has minimums of $25 per portfolio or $15 per portfolio (automatic plan). Both plans don’t have any state residency requirements.
Advisor-Sold Savings Programs
The benefit of advisor-sold programs is that you don’t have to select the plans on your own. However, the expertise may come with sales charges or other charges.
The New Jersey Franklin Templeton has initial contributions of $250 per investment (lump-sum) and $25 (per month). There are no residency requirements. However, residents who opened their account on or after June 29, 2021, may be able to get a dollar-for-dollar (initial deposit) grant of up to $750.
Prepaid Tuition Plans
As the name suggests, these tuition plans allow you to purchase units or credits for future tuition. With prepaid plans, you can lock in current tuition prices to pay at eligible colleges and universities.
Like savings plans, prepaid tuition plans don’t come with any federal guarantees. The situation at the State level varies, with some States guarantying for the money you put into the account.
Prepared plans aren’t very common and are usually offered by public institutions. They also often come with an in-state residency requirement for you and/or the beneficiary. If you decide to go out of State, you may transfer the funds to another account or apply for a refund. In terms of fees, prepaid plans may come with application or enrollment fees and administrative fees.
PREPAID CONTRACT PLANS
With the prepaid contract option, you can buy a contract for one to five years of tuition. The plans accept payment as an installment or lump sum.
States with prepaid contract programs include Florida, Nevada, Massachusetts, Michigan, etc. Florida’s Stanley G. Tate Florida Prepaid College Program requires the saver or beneficiary to be a resident for 12 months before enrollment.
With the unit option, you pay for the tuition in ‘units.’ A unit may be equal to hours or credits.
Washington’s Guaranteed Education Tuition (GET) Program requires you or the beneficiary to be a resident at the time of enrollment. You must use the units within 10 years of the projected starting year or when you start using the units.
The ABLE Plans are for people with disabilities. As with other plans, the requirements vary from State to State.
New Mexico’s ABLE NEW MEXICO has state residency requirements, while California’s CALABLE program does not have any such requirements. The account balance limits are $501K and $529K for the California and New Mexico programs respectively. In both States, you can open an account with $25.
*State program stats gathered from Savingforcollege.com.
USE OF FUNDS
The main purpose of the 529 plan is to save for college, but you can use the funds in multiple ways. Firstly, you can use the money to pay for other types of education, including trade and vocational schools and 2-year associate degrees.
If you don’t need to pay for a college education or need the funds for school tuition, you can use the plan to pay up to $10,000 per year for K12 schools. This includes public, private, and parochial schools. There is no restriction on changing the beneficiary – you can choose a family member and select yourself as the receiver.
You can also use your 529 funds for non-educational purposes. However, this will mean that you pay taxes on gains and a 10% penalty. Therefore, it’s a good idea to calculate if it’s better to use the funds for a non-educational expense or keep it for later.
DRAWBACKS OF 529 PLANS
There are obvious benefits of a 529 plan, but there are also some possible drawbacks you should keep in mind:
- 529 Plans can affect the beneficiary’s ability to receive need-based financial aid. Therefore, research the policies of your target schools on this issue.
- Another possible drawback is that your money gets tied to a specific purpose (education) and for a long period. If you need the money for any other reason than education, you’ll have to let go of the tax benefits and pay 10% on your earnings.
The connection between higher education and gainful employment is still a strong one. The 529 plan is one of the better options for saving for college because of the tax advantages and the variety of options on offer.