Episode 83 529 Plans

There are two types of 529 plans: prepaid tuition plans and education savings plans. Today I'm only focusing on the 529 Education Savings Plan which is an investment account you use to save for future education tuition and expenses. The plans are set up by each state. You to invest your savings in the plan, where your investment grows tax-free. And when you withdraw the money for approved education expenses, that distribution is also tax-free. 

You can use it to pay for higher education tuition, mandatory expenses, room and board at any college or university, and some vocational schools. Now 529 accounts can also be used for up to $10,000 a year of K-12 school tuition only.

If you pay state income tax, you may get a break for your 520 contributions, including deductions on your state income tax or getting matching grants. You'll only be eligible for these state specific benefits if you invest in a 529 plan sponsored by your state of residence. It’s important to note that you can participate in ANY state’s 529 plan. Look at the plan’s administrative fees and investment fees. If you don’t pay state income tax, like many active duty military, you may be best off going with a plan with lower fees, better customer service, and/or investment options that best fit your needs. Details are on each plan’s website. There are also websites you can use to compare different states plans. A great place to start is Morningstar’s 529 plan ratings. https://www.morningstar.com/articles/1006084/the-top-529-college-savings-plans-of-2020

Anyone can open a 529 account for a designated beneficiary, family, friends and even the designated beneficiary themself. Anyone can contribute to the 529 plan once it’s open. Many plans also make it simple for others to gift money to the 529 account, like providing a donation link unique.

You typically choose from a range of investment portfolio options that often include mutual funds or exchange traded fund. Many also include age-based portfolios, which automatically shift from more aggressive investments to more conservative  investments as a beneficiary gets closer to college age. Give these  a look if you’d like to fire and forget.

529 accounts owned by a parent or dependent student are count as parental assets toward your expected family contribution. Higher expected family contribution can mean lower financial aid. Parental assets are counted to a max of 5.64% which is more favorable than student assets which are counted at 20%. So accounts owned by parents or the student may decrease financial aid. But not as much as if the student had the savings outside of a 529 account.

Assets held in 529 plans owned by grandparents or anyone else have no affect on the FAFSA. But when funds are distributed to pay for college expenses, it will be counted as student income on the FAFSA. One strategy to avoid this problem is  wait to withdraw funds until after the student’s third semester of college, since the FAFSA looks at income from two years prior. 

The owner that opened the account can change the beneficiary at anytime. There is a long list of people you can make a new beneficiary, including nearly any relative of the beneficiary. And you can change the beneficiary more than once. Check with your plan to see who qualifies. 

If you withdraw money from a 529 plan that is not used for qualified education expenses it may be subject to both state and federal income tax and an additional 10% early distribution penalty. There are a few exceptions to the penalty if the beneficiary dies or becomes disabled. 

 One last note for parents. Remember, you can borrow money for college, but you can’t borrow for retirement.  At a bare minimum invest enough in your TSP or 401k to get any match. 

Transcript

Announcer: 0:14

Welcome to the Money Pilot Financial Advisor podcast, where you team up with Money Pilot founder, former Army helicopter pilot and your host Katie Cannon to put your money where your heart is. Together, we'll tackle issues big and small so you can take charge and land your financial life

Kathleen Cannon: 0:53

Hello, and welcome back to the podcast. Today we're talking about college 529 savings plans. There are two types of 529 plans, the prepaid tuition plans and the education savings plans. With a prepaid tuition plan, you purchase units or credits at participating colleges and universities, which are usually public and in state for tuition and mandatory fees. These plans are fairly restrictive and often not the best option for most people. If you want to lock in tuition at a particular university years in advance, a prepaid tuition plan might be a good fit. If this sounds like you check them out. Just read the fine print carefully to understand the details and restrictions. Today, I'm only focusing on the 529 Education Savings Plan, which is what most people think of when they hear 529 plan. We'll cover what a 529 Education Savings Plan is, what you can use it for, the tax benefits, and possible penalties, how to choose a plan and options if in the end, you don't use it. A f529 plan is an investment account that you can use to save for future education, tuition and expenses. The plans are set up by each individual state. So each plan is a little different. But all 529 accounts allow you to invest your savings in the plan where your investment grows tax free. And when you withdraw the money for approved education expenses, that distribution is also tax free. And this is awesome. It's it's like a Roth account for education. You can use it to pay for higher education, tuition, mandatory expenses, room and board at any college or university and some vocational schools. Now 529 accounts can also be used for up to $10,000 a year of private primary and secondary school tuition. But when you use a 529 for K through 12, you can only use it for tuition, not room and board or other expenses. So the rules are more restrictive than using it for college. Especially if you pay state income tax, you may get a break for your contributions to a 529 plan. This may include deducting contributions from your state income tax, or getting matching grants. Now you'll only be eligible for these state specific benefits if you invest in a 529 plan sponsored by your state of residence. And it's important to note that you can participate in any state's 529 plan. So shop around to see which best meets your needs. And don't forget to look at the plans, administrative fees and investment fees as well. If you don't pay state income tax, like many of our active duty military, you may be best off going with a plan with lower fees, better customer service, and or investment options that best fit your needs. You'll find all the details on each plans website. Just search your state and 529. There's also websites where you can compare different states plans and a great place to start his morning stars 529 plan ratings. I'll put a link to that in the shownotes. Now anyone can open a 529 account for a designated beneficiary. That means relatives family, friends, and even the designated beneficiary themselves can open the 529 plan. The person opening the account will need the beneficiary's name and social security number. So be very careful who you give this information to, it may be best for you to open the account for your child for example, and invite others to contribute. And anyone can contribute to the 529 plan once it's open. Many plans also make it simple for others to gift money to the 529 account, like providing a donation link that's unique to that particular account that you can share. Remember, anyone can open a 529 and anyone can contribute to the plan for the designated beneficiary. One thing I'd like to emphasize is that 529 savings plans can be used to pay for education in any state, it doesn't matter which state you open the 529 plan in. Once the account is open, you typically choose from a range of investment portfolio options that often include mutual funds or exchange traded funds. Many also include age based portfolios, also known as target date portfolios, which automatically shift from more aggressive investments to more conservative investments as the beneficiary gets closer to college age. And this helps the value of the account grow faster earlier, though with more market ups and downs, then settle into a slower growing steady your investments. As the beneficiary gets closer to starting college. Definitely give these age based portfolios a look, especially if you like to fire and forget. Now if you're a parent or a student beneficiary, you may be wondering how a 529 account affects your eligibility for financial aid. 529 accounts owned by a parent or dependent student are counted as parental assets toward your expected family contribution. Higher expected family contribution means lower financial aid. Now parental assets are counted at a max of 5.64% which is more favorable than student assets which accounted at 20%. So accounts owed by parents or the student may decrease financial aid, but not as much as if the student had the savings outside of a 529 account. Okay, now, assets held in 529 plans owned by grandparents or anyone else have no effect on the FAFSA. But when the funds are distributed to pay for college expenses, it will be counted as student income on the FAFSA. Now 50% of student income is counted in the expected family contributions and would decrease eligible financial aid. Ouch. But one strategy to avoid this problem is if the student will graduate in four years, grandparents or others can wait to withdraw funds until after the student's third semester of college. Since the FASFA looks at income from two years prior. So again, assets in 529 accounts owned by the student or parent will decrease financial aid. But no more than and maybe less than if they had invested the money elsewhere. Assets held in 529 accounts owed by anyone else, including relatives only affect financial aid when the funds are withdrawn. So wait until the last two years of college to withdraw and it will not have any negative impact. So far, we've covered the who, what, when, where and how of opening and funding a 529account. But what happens if your plans change, like the beneficiary gets a big scholarship or goes to a service academy, or bypasses college altogether and doesn't need the 529 for authorized education expenses. First, the owner that opened the account can change the beneficiary at any time. There's a long list of people you can make a new as a new beneficiary, including nearly every relative of the beneficiary, children, grandchildren, parents, grandparents, uncles, aunts, and first cousins of you or your spouse and more and you can change the beneficiary more than once. So check with your plan to see who qualifies if this is something you're interested in. The main downside to five to Line accounts. If you withdraw money from a 529 plan that is not used for qualified education expenses, it may be subject to both state and federal income tax and an additional 10% early distribution penalty. There are a few exceptions to the penalty if the beneficiary dies or becomes disabled. But otherwise, 529 accounts are a great savings tool as long as they're used for education. One last note for our listeners out there that our parents. College tuition and costs have really skyrocketed since many of us went to school. And many of you would like to find ways to help your kids save for college and avoid student debt. But remember, you can borrow for college, but you can't borrow for retirement. Carefully consider this before decreasing your retirement savings in order to save for a child's education. At a bare minimum, invest enough in your TSP or 401k to get any match. Think of the airline safety brief, where you're cautioned to put your own oxygen mask on before helping others to best ensure everyone's well being. I hope you found today's podcast helpful and we'll talk with you again soon.

Announcer: 11:28

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