6 Questions About 529 Plans - What parents must know about saving for college

My son, Andrew, is starting college soon. Fortunately, we have saved a decent amount over the years, so I’m not overly worried about cash-flow for the next several years.

If you’re saving for your child’s (or grandchild’s) higher education, you probably have many questions besides “When did college get so incredibly expensive?” My favorite college savings tool is the 529 Plan.

Started in the late 1980s and operated by states and financial institutions, the 529 College Savings Plan offers tax-advantaged ways to save for various costs of higher education. What else should you know? Here’s a list of commonly asked questions:

What can my child use 529 money for? The money can pay for qualified expenses such as tuition, fees, books, supplies, computer-related costs and room and board for someone who is at least a half-time student. Pizza, burritos and beer don’t qualify.

How much can I contribute? The answer is not as straightforward as with an individual retirement account or 401(k) retirement plan. There are no annual contribution limits for 529 plans. However, plans typically have maximum (total) contribution limits around $350,000 per beneficiary.

If you are making substantial contributions, you have to pay attention to federal gift tax laws. A gift of more than $14,000 to a single person in one year requires that you file a gift tax return. 529 plans are unique as they allow an individual to contribute up to a $70,000 (married couples up to $140,000) gift tax-free in one year to an account for a beneficiary.

There are no age or income restrictions to contribute.

What if our relatives want to contribute? Family members can either open a 529 account and name your child as the beneficiary or contribute to an existing 529 they don’t own.

If your family members contribute to a 529 account that they do own, they can receive a state tax benefit if their state offers such a deduction (California does not offer this deduction). Opening just one account for the beneficiary and letting your family help fund it is usually simpler.

Why use a 529 over a regular taxable account? These accounts defer taxes and contributions grow tax-free if you use the funds for the qualified expenses mentioned earlier.

This beats paying the government for an after-tax account – but the latter offers complete flexibility on where and how you can spend the money. A 529 doesn’t.

What if my child gets a full scholarship? You can withdraw from the 529 without penalty, though you’ll pay taxes on the earnings. You can also use your 529 to pay for expenses that the scholarship doesn’t cover, such as room and board, books and other required supplies. In addition, you might need the 529 funds to pay for graduate school.

What if my child does not want to go to college or doesn’t use all of the money available? You can change the beneficiary to another family member (a sibling, first cousin, grandparent, aunt, uncle or yourself, for example), and the money goes toward that person’s education. Most plans allow you to change your beneficiary only once a year.

Remember too that these funds can help pay for two-year associate degrees, and for trade and vocational schools.

A final option: Withdraw the money, or cash out the plan. You pay income tax and a 10% penalty on the earnings, but not on your contributions. This is not a financial disaster as the account has received tax-deferred growth that offsets most/all of the penalty.

If unsure whether your child is headed to college, sit tight on cashing out. One thing you will learn fast about young adults: life can always change.

Are you concerned about college breaking the bank? Give me a call at (949) 441-4410 and we can discuss college funding strategies.

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