529 Accounts: The Basics Part 2

Continuing from last week, here is the remainder of Dr. Anne Champeaux’s guest post on the basics of 529 accounts.

What plan should I open?

#1 State Tax Benefits

There are 50 states and 50 plans. You can own a plan in any state. Are you confused what state website to go to for opening a plan?

There ARE a few things to consider in this decision, the largest being if your state offers any sort of state income tax savings by opening up a specific plan.

For those who lives in states without an income tax this doesn’t apply. 

For other parents, inquire what tax savings are available.  Some states you MUST open the plan in your state.  Some states will give parents a tax deduction no matter what state the plan is in.

These are state-specific rules, so you need to look at your state plan and inquire if there are state tax perks. 

Parents can make this as easy or as complicated from there. Some parents will put in money in their own state plan up to the allowable limit for the state income tax deduction. After that, money is put in another state plan with cheaper plan fees.  Most parents use one plan for simplicity. 

Some parents will opt to find a state which uses the same financial institution to hold the 529 plan as where their other assets are held (example parent’s 401K is held at Vanguard so parent opens up a plan in a state which also uses Vanguard for holding the 529).  This allows convenience to sign in and manage all accounts at one institution.

#2 Plan Fees

Fees are the other consideration. A parent can shop around states for plans which offer the lowest plan fees and fund fees.

I randomly researched a few states for overall fees for investing into a single 100% US equity fund along with plan and administrative fees.

  • Connecticut: 0.160%  An account with $100,000 would cost $160 in annual fees
  • Georgia: 0.900%  An account with 100,000 would cost $90 in annual fees
  • Ohio: 0.155%  An account with $100,000 would cost $155 in annual fees

So yes, fees will cut into the overall growth of the account, but it only took me a couple minutes to research.

There are a few “popular” state plans to include New York and Utah, but I recommend parents research a few plans to include their own state plan before making a final decision.

Last point of clarification on which plan to open; 529s are state-run plans, NOT financial institution owned plans. There is no such thing as a “Fidelity-owned 529 plan”.  But yes, Fidelity will administer plans for various states such as Arizona and Delaware.

We have collected multiple 529 plans over the years (we opened plans for son, niece and nephrew) and two plans have been transferred by the states to different financial institutions over the course of ownership.  For instance, one plan used to be held at TIAA-CREF and now is at Fidelity. 

Remember you are in contract with the state, NOT the financial institution.  Plans can be changed at the state’s discretion.  Investment choices are also subject to change within the plan along with fee structures. 

How much should I save into the 529 plan?

Loaded question. This is a very individual decision, and it is somewhat a ballpark guess because of the multitude of factors related to paying for higher education.

  • How many kids to you need to save for?
  • How many will be in college at the same time?
  • What can you afford to pay for without the 529 plan savings?
  • Do you think your children will go to public, private, in-state, out-of-state university or other type of higher educational institution? 

There are various online calculators parents can use to help decide how much to save.

The question to ask is that if you decide not to save into a 529 plan, what are you going to do? 

Gifting Regulations

Of note, 529 plans fall into IRS gifting regulations. 

What does this mean? The IRS allows each person to annually gift $15,000 to another person (like a child) without the need to file IRS form 709. This is how the IRS keeps record of your estate tax exemption should a person go over the annual gifting limit. (Gifting, gift tax and estate taxes and exemption are another discussion).  Here are some examples:

George gifts (contributes) $15,000 into his son’s 529 plan.  His wife also gifts $15,000 into this plan.  No IRS paperwork required.

Tom gifts $15,000 into his son’s 529 plan, $15,000 into his oldest daughter’s 529 plan and $15,000 into his youngest daughter’s 529 plan.  His wife does the same. Total money gifted per the couple is $90,000.  No IRS paperwork required. Each person gifted up to the limit to separate children.

Mark gifts $15,000 into his son’s 529 plan.  He also gives his son $800 for his birthday and deposits the money into his son’s savings account.  Mark went over the gifting limit ($15800) and will need to file IRS form 709. 

Superfunding the 529 account

Lisa and Jeff (yes, I grew up in the 1970s) decide to “superfund” the 529 plans.

What does this mean? This IRS allows 5 years’ worth of gifting in a single year, but then the individual(s) are disallowed from other gift contributions for those 5 years.

This strategy allows the money to compound maximally.  IRS form 709 must be filed, but there will be no effect on the couple’s estate tax exemption.

Filing the form is primarily for record keeping such that the IRS knows there can be no other gifts for those 5 years. (And remember this includes gifting into other accounts such as savings accounts or custodial accounts/UTMAs).

A parent can put as much or as little into a 529 plan. Even small pots of money can help students pay for books, summer courses, or offset living expenses.

Can a grandparent or other relative open up a 529 plan?

Yes.

Word of warning, the grandparent is the owner of the account. The money being used for your child’s higher educational expenses is not guaranteed.

Grandparents may need the money for healthcare or long-term care.  

On the flip side, one advantage is that accounts not owned by parents will not be considered in need-based aid equations by financial aid offices.  This is largely not a concern for physician families. 

How do I actually use the 529? 

Most plans give three options

  1. Pay the school directly
  2. Pay (reimburse) the account owner
  3. Pay (reimburse) the beneficiary. 

I pay myself. For example I bought a computer with the 529 plan and paid for it with my credit card, received cash back and then took that money out of the 529 to reimburse myself. 

Money pulled out of the 529 plan must be used for expenses which incurred the same year.

This includes if a parent chooses to take out equivalent scholarship money. 

I keep a spreadsheet of qualified expenses and 529 withdrawals in case I am audited. 

Each year the 529 plan will send the owner a 1099-Q which documents how much money was taken out. 

If any money is withdrawn for a non-qualified expense this is reported on taxes so the account owner would pay the appropriate penalty and taxes.

Qualified withdrawals are not taxable. Keep good records. 

We only have one child, but for those parents with more than one child, be aware you can only use a 529 plan for one child at a time.

You cannot pay expenses from the same account for two different children at the same time.

Plans will allow you to change the beneficiary from one child to another; but most plans allow this change only once per year or only within specified time periods.

Therefore, for simplicity I recommend each child has their own account. 

Leftover funds in accounts after a child finishes their education can be rolled into other remaining accounts. 

Parents can opt to hold onto 529 accounts with remaining balances to use for future grandchildren, themselves, or other qualified relatives. 

We will have a small amount of funds left over in our 529 account. 

What about 529 prepaid plans?

Yes, I mentioned these plans earlier. They are not offered by every state.

In fact, as of last fall there are only 9 states remaining who have these plans open to new account enrollment.

Think of these plans as the US Postal Service Forever stamp. 

You buy the stamp today at its current value, and you can use the stamp at a later time no matter what the future cost of postage is. 

Parents can essentially lock in future tuition cost at the current rate. 

Each state plan is unique.  Most offer tuition plans, some states with add-on room and board plans for additional cost.

These plans CAN be used anywhere in or out of state, but the plan worth is determined by the state based on state tuition rates. 

Some states have time limits to use the plan (there is no time limit for non- prepaid 529 plans).

Their best value is when used in the state they were opened.

They may or may not grow to outpace a non-prepaid 529 plan.

Some states guarantee parents will at least maintain the value of the initial investment.  This has not always been the case.  There have been few instances where states lowered tuition rates and the value of these plans was less than the initial investment.

Many pre-paid plans were discontinued (Historically nearly 25 states offered plans). Some states gave parents refunds.

Look for guaranteed plans.

Most states allow transfer of the plan to another beneficiary. 

I have seen some families with more than one child “diversify” by opening up a prepaid for one child and a non-prepaid for the other children.

I think it is worth researching a prepaid plan in your state if your think it better fits your needs and investment risk style.

Largely prepaid plans are dropping out of favor.

Before investing in a state plan, be sure to read the information provided on the state website. At a minimum review offered tax incentives for contributions, plan and fund fees, and investment options. 

Final thought

A parental-owned 529 plan is a great and easy way to optimize college savings.  

I hope this was helpful as you plan to save for your child’s education. Pen down your thoughts and comments below!

Want to learn more? 

  • savingforcollege.com: a comprehensive website for all things related to saving for college, including 529 accounts
  • How to use 529 account as a generational wealth transfer tool: Barrons.com
  • The Price You Pay for College: by Ron Lieber (this is an affiliate link: click on it and I may earn a penny or two in commission)

This Post Has 3 Comments

  1. Brian

    Just like your 401k, keep adding to a 529 plan for your children and one day you’ll look at the balance and be surprised how much money accumulated for their education!

    1. admin

      So true. Good investing a long game.

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