529 Plans, What Are They?
August 18, 2014
Original story by Michael Solari. You can view it here.
Aw, college, the good ol’ days! Now that you’re a bit older, have kids, and more responsibilities you may have heard of the term ’529 plan.’ Besides wishing that your parents set one up for you, what else do you know? 529 plans were established not too long ago for parents & grandparents to help save for their kids/grandkids college education and have become increasingly popular as college tuition continues to rise.
How they Function
529 plans are accounts that can be opened by any individual (called a custodian) looking to provide funding for someone (called a beneficiary) going to college (not all colleges are eligible so check here to see if yours is). Like I mentioned above, they are mostly established by parents or grandparents to help with the cost of future college expenses. Money contributed will grow federally tax free if money is spent on qualifying college expenses which include, tuition, books, supplies, and some equipment.
Each plan will vary from state to state because they are regulated individually. That does not mean, however, that you need to open up an account in the state that you currently reside. Some states give a state tax deduction if you make contributions into the plan where you reside. When selecting a plan, check to see if your state offers this as this would be a big incentive, however, not the only item to look for. I recently helped open up a 529 plan in another state because New Hampshire does not have a state income tax.
Like 401(k) plans you are restricted to the funds available in each plan. Another reason to do your research when looking to open up an account. States will usually select a mutual fund company to offer their funds. Remember, cost matter, so look for funds that offer low expense ratios.
The maximum contribution is what really makes these accounts sweet. You are eligible to put in up to the annual federal gift exemption for each account. That means you can contribute up to $14,000 this year for each account. If you had 3 children you could contribute $42,000 this year. But wait, that’s not all! You are also allowed to ‘super fund’ the 529 plan. You are allowed to gift up to 5 years of the gift exemption in one year. That is a maximum of $70,000 for each 529 plan. Going back to my example, that is a total of $210,000 in one year that you can contribute into these plans (please note that you cannot gift anything additional during these 5 years). I would caution if you plan to contribute big dollars into these plans because they could affect other goals you may have. Plus, who knows your child might be ‘wicked smaht’ and get a scholarship. Then what do you do with the money? Well, you can always change the beneficiary to another child but you don’t want to be left with a big balance after your children have graduated from college.
Advisor or Direct Plans
In addition to trying to figure out where to open an account you must also consider whether you want an advisor-sold or direct-sold plan. Basically, the difference in terms means, do you want to work with a commissioned based financial advisor or would you rather do it on your own. Working with a commissioned financial advisor will cost more and their fees are buried in the commissions of the mutual funds you purchase (fee-only advisors will also help and will most likely help establish a direct plan as they do not accept commissions). Take a look at the expense ratios of an advisor plan vs. direct and you will see that the costs are quite different. A good advisor will help you create a plan that incorporates all of your goals (retirement, new home, travel, car, etc.) along with funding for college education. If you don’t have the time or the experience then it makes sense to hire an advisor.
There is so much to think about when you have a child so it’s even tougher to think about them when they’re college bound! First, decide whether you will do this on your own or if you need help. The next step is to see if your state will give you a deduction on contributions and finally, think about the mutual funds you want to invest in. For more information about 529 plans and how your state stacks up, check out savingforcollege.com.