5 Reasons to Fund a 529 College Savings Plan

UNH Hat

1) College is Expensive

 

Financing a college education today can be a big challenge.  Having written some checks for college I find it handy to have a cold six pack close by. According to the College Board, the average tuition, room, and board at a private, nonprofit, four year school for 2014-2015 was $42,419.  The cost of a public, four year out-of-state school was $32,762.¹   Either way, these are very big numbers.  And that is for one child!  Keep in mind these are also national averages.  It’s very easy to see prices far in excess of these at private schools in New England.  Additionally, many recent college graduates have had difficulty finding suitable employment that would reflect having a college degree. We’ve all heard stories of college graduates living in their parents’ basement and working part-time as a barista at Starbucks.  No need to have a four year college degree to do that.  One reason for this is the continued impact of the Great Recession of 2008-2009.  This has caused businesses to be very slow to hire.  When they do hire, they are generally looking for some work experience.  The sharing economy (Uber, Task Rabbit, etc.) has also changed the demand for full-time labor.  It looks like a number of folks are free agents now.  Getting part-time gigs may be the norm for many.

2) Tax – Free Growth

 

Qualified distributions from a 529 College Savings Plan (“529 Plan”) are income tax-free.  Qualified distributions include distributions used to pay for Tuition and Fees.  Also books, supplies and equipment, and room and board. Any distributions made from a 529 Plan that are not qualified are taxed as ordinary income.  Additionally there is a 10% federal income tax penalty.

3) You Stay In Control

 

When a 529 Plan is opened there is what’s called the account owner.  This is typically the grandparent or parent that is setting up the account.  Only they have the authority to make distributions from the 529 plan.  A successor account owner should also be listed in case the owner passes away or becomes incapacitated.  The successor account holder is typically a spouse if the parents set up the account.  If the grandparents set up the account they may name their spouse as the successor or perhaps one of the parents of the grandchildren. With a 529 plan there is also a beneficiary named. This is typically the child or grandchild. If the child that is named as the beneficiary does not go to college it is not a problem. The account beneficiary can be changed to another child or another family member.  Control is an important element with the 529 Plan.  Back in the day (before 529 plans) Uniform Gift to Minor Accounts (“UGMA”) were the primary tool used to invest in a child’s name.  The issue with these accounts is that the assets need to revert to the minor when they become age of majority.  In many states the age of majority is either age 18 or age 21.  Giving children or young adult’s access to a large sum of money at young age might not be in their best interest.  They may develop “Lamborghini Fever.”  This fever affects young adults (particularly males) that come into a large sum of money at a young age.   This is not an issue with the 529 plan.  The funds do not revert to the beneficiary when they reach the age of majority.  Funds are only distributed when the account owner decides.

4) Fund Up Five Years Up Front

 

Taxpayers may make gifts up to $14,000 per year to an unlimited number of people without having to file a gift tax return or pay a gift tax.  However, with the 529 College Savings Plan there is an additional benefit. A grandparent or parent can fund up to five years of annual gifts to a grandchild or child in one year. They are allowing for the funding to be made up front and treating the contribution as it was being made ratably over the next five years.  For example, a father could fund $70,000 ($14,000 annual exclusion times five years) all in one year for his daughter.  This allows the funds to be in the 529 plan sooner and to allow for more tax-free growth. This would however require the filing of a gift tax return. It may not result in a gift tax being paid however.  Taxpayers have a federal estate tax exclusion of $5.43 million in 2015.  This exclusion is indexed to inflation and will increase annually.  When gifts in excess of the annual exclusion of $14,000 are made, this reduces the exclusion allowed at death.

5) Possible State Income Tax Breaks

 

Connecticut residents that fund a Connecticut Higher Education Trust (“CHET”) can deduct up to $10,000 on their Connecticut Income Tax Return annually. The $10,000 deduction is for a married couple filing a joint tax return.  Single filers are allowed to deduct up to $5,000.  For most Connecticut Income Taxpayers this would mean saving about $500 of State Income Tax. Check with your state 529 Plan to see if they offer residents any income tax breaks.  There is no income tax deduction on the Federal Income Tax Return.  529 plans offered outside their resident state may not provide the same tax benefits as those offered within their state.

 

1 The College Board

 

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Thomas F. Scanlon, CPA, CFP(r) and not necessarily those of RJFS or Raymond James.  Expressions of opinion are as of this date and are subject to change without notice.  Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing.  This and other information about 529 plans is available in the issuer’s official statement and should be read carefully before investing.  Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.

 

 

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