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For many people, their biggest expenses in life are funding retirement, buying a home and paying for their children’s college education — or a portion of it, anyway. Setting aside money for these and other financial goals is difficult, especially when you’re trying to save for them all simultaneously and from a young age.
One of the more popular college savings vehicles is the 529 College Savings Plan. Every state and Washington, D.C. offers at least one 529 plan option, although most offer several. Key features include:
• You make contributions using after-tax dollars; their investment earnings grow tax-free.
• Withdrawals aren’t taxed if they’re used to pay for qualified higher-education expenses (e.g., tuition, room and board, fees, books, supplies and equipment).
• If you withdraw the money for non-qualified expenses, you’ll have to pay income tax and a 10 percent penalty tax on the earnings portion of the withdrawal — plus possible state penalties, depending on where you live.
• Many states that have a state income tax give accountholders a full or partial tax deduction for contributions made to their own state’s plan. Three states (Indiana, Utah and Vermont) also offer tax credits for contributions.
• Contributions to other state’s plans generally are not tax-deductible in your home state; however, five states do offer tax breaks for investing in any state’s plan (Arizona, Kansas, Maine, Missouri and Pennsylvania).
• Each state’s plan offers different investment options, both in investment style (age-based, risk-based, principal protection, managed, or indexed funds, etc.) and in actual investment performance.
• You can choose anyone as beneficiary — your child, other relative or friend.
• If the original beneficiary decides not to attend college or gets a scholarship, you can reallocate the account to another of his or her family members at any time.
• You can rollover funds to a different 529 plan or change investment strategies once a year. If you want to do more than one rollover within a 12-month period, you’ll need to change the beneficiary in order to avoid taxes and penalties. (You can always change it back later.)
• Contributions up to $14,000 a year, per recipient, are exempt from gift taxes ($28,000 for married couples).
• You can also make a lump-sum contribution of up to $70,000 ($140,000/married couples) per beneficiary and then average the contribution over a five-year period without triggering the gift tax — provided you make no other gifts to that beneficiary for the next five years.
• These plans are treated as an asset of the account owner (vs. the student) when calculating the expected family contribution toward college costs, so they have a comparatively low impact on financial aid eligibility.
Most financial experts recommend looking first at your own state’s plan to see what tax advantages, if any, are offered to residents. They may be significant enough to offset lower fees or better fund performance in other states’ plans.
Carefully examine the fee structure. Common fees include those for opening an account, annual maintenance, administration costs, and most importantly, sales commissions if you’re buying from a brokerage — which could be up to 5.75 percent of your contribution. Buying directly from the plan eliminates sales fees but puts the onus on you to research the best option for your needs.
And finally, examine the investment performance of the funds, both when you enroll and periodically thereafter. Morningstar (morningstar.com), College Savings Plans Network (collegesavings.org) and FinAid (finaid.org) all have helpful comparison tools.
Bottom line: The sooner you can start saving for college, the less your kids will have to rely on expensive loans.
Jason Alderman directs Visa’s financial education programs.