Monday, December 11, 2017
All 529 plans come with unique requirements you’re better off knowing ahead of time
A 529 plan can be one of the best investments you ever make, especially if you’re able to put away enough to cover all your child’s college expenses. However, in some rare instances, a 529 could be your biggest regret if you don’t do your homework.
For starters, every state handles 529 plans differently, and you’ll need to follow your state’s rules to ensure that you don’t diminish your return on investment due to financial missteps. There are several “gotchas” to look out for if you want to get the most from your savings strategy. Beware of these five costly missteps that could derail your college savings plan.
529 College Savings Series
- Saving for College: What is a 529 Plan?
- When Should I Start Saving for College?
- 529 Plans: How to Plan for Merit Aid
- How Do Colleges Determine Financial Need?
- College Financial Aid: What Forms Do I Need to Fill Out?
- How to Help Your Child Make Mature Decisions on College and Their Career Path
1. Failing to Price Shop 529 Plans
Just as you would compare prices and features on a car or other major purchases, be equally studious when choosing a 529 plan. Shopping for the right plan can help you avoid higher fees, giving you a bigger return on your investment over time.
For example, some funds charge 150 basis points (1.5 percent) to invest in the S&P 500, which is an astounding seven times more than you need pay (Brighton Jones can provide S&P 500 access at a low cost through the 529 plans we recommend). These costs have a real impact on the amount of money available when the beneficiary heads off to college. Be sure to evaluate all fees prior to enrolling in a plan.
As mentioned above, plans can vary from state to state. Some states give you zero tax benefits unless you invest in a plan within your home state. Other states (including AZ, KS, ME, MS, MT, and PA) are “tax-parity” states, which give you benefits regardless of your plan’s home state. It literally pays to do your research or talk to someone who’s already done the work for you.
2. Overfunding Your 529
Yes, there is such a thing as saving too much for college. Many states max out 529 funds at $300,000, but that contribution limit may rise as college costs continue to climb. In addition, if you contribute more than your child needs for college (e.g., investing enough for four years but your child graduates in three years), the remaining funds not used for qualified education expenses (there may be some transfer opportunities to other beneficiaries) will be subjected to tax plus a 10 percent penalty on the earnings.
Also, be aware that you can overfund your 529 plan in any given year. $15,000 per parent can be contributed per year, or $30,000 per couple, starting in 2018. Grandparents’ contributions are not counted toward these limits. If contributions exceed the yearly limit, then the amount over the limit must be reported to the IRS as a gift. One exception is a “super contribution” of $70,000 per person (or $140,000 per couple) in a single year, which precludes a federal tax exclusion for five years.
If money is left in your 529 after graduation, then you can change the beneficiary to another member of the family once a year. Check with the IRS or your financial advisor on the details. New beneficiaries may include a spouse, sibling, father or mother, son or daughter, or the spouse of any individual listed above.
While the beneficiary can be switched to another family member, it cannot skip to a younger generation (i.e., if an individual is funding a 529 for their child, and the child decides not to attend college or doesn’t use all the funds, the funds cannot then be transferred for benefit of a grandchild).
Another option is to roll the funds into another one of your children’s plans. Both options are penalty-free, if done within the guidelines.
3. Paying State Tax When Changing 529 Plans
A rollover to another state’s 529 plan may seem promising, but it’s crucial to consider what you stand to lose in addition to the benefits you’ll gain. If you move to another state and want to invest in its 529 plan for better tax benefits, you might end up paying additional fees as a result. Rollovers can present huge investment setbacks. It’s in your best interest to speak to a financial advisor who can help you uncover any state-specific income tax issues and address them accordingly.
4. Using 529 Plan Money for Non-Educational Expenses
529 funds withdrawals are tax-free for qualified higher education expenses only, which doesn’t include repayment of student loans, travel, health clubs, insurance, medical bills, or dorm furnishing. Also, you cannot withdraw above and beyond the student’s qualified higher education expenses, which include; tuition, room and board, books, and technology less grants or scholarships.
In other words, only true out-of-pocket expenses are eligible. Also, you cannot reimburse for room and board above what is charged by the university. If your 529 plan funds are used for non-qualified expenses, you’ll have to pay federal income tax and possibly state tax on the earnings portion of that withdrawal plus a penalty which defeats the entire purpose of tax-free savings with a 529 plan.
Withdrawals are tax-free for qualified expenses only, which doesn’t include repayment of student loans, travel, insurance, medical bills, or dorm furnishing.
Other key considerations are:
- Keep thorough records: Some expenses—like tuition—are easy to track, especially if your 529 plan directly pays the school. If you are paying for an apartment, technology, or other qualifying expenses directly, be sure to keep the lease or receipts along with the annual statement from your plan administrator. The IRS holds you accountable to establish that an expense is a qualified withdrawal.
- How to avoid penalties due to a misstep: If you spend money that doesn’t meet the qualified criteria, then the money can be redeposited into the 529 plan within 60 days without penalty. Also, the penalty can be waived for certain circumstances, such as the student receiving a scholarship or some other non-taxable education assistance.
5. Failing to Read the Fine Print Prior to Plan Enrollment
All 529 plans come with unique requirements you’re better off knowing ahead of time. Make sure you understand the details of your chosen state’s plan, such as the flexibility to attend a school outside of the plan’s state.
Some 529 plans (Pre-Paid Tuition Plans) sell you tuition credits to be used in the future. Rather than investing in a special saving account like an IRA or 401(k), you buy tuition vouchers to be used later at eligible universities with some 529 plans. Typically, these plans charge a premium over the cost of tuition today, though the credits may seem like a terrific value given that college tuition has grown much faster than inflation.
The catch is that most states do not actually guarantee that the full amount of tuition will be covered. If tuition grows more than the premium charged when purchased, then fees or other assessments may be charged to make up the difference. Some states do guarantee that tuition credits will cover the actual costs—that’s why the fine print is so important.
Navigating 529 plans isn’t always intuitive. If you have questions, contact one of our Certified Financial Planners to discuss your options and help you get the most from your 529 investment.
Brett Carolan, CFP® serves as an advisor at Brighton Jones.
Read other posts in our 529 College Savings series: