The cost of college tuition continues to increase every year with most college planning experts projecting a 6% annual increase each year. One might ask, “How do I save for my child’s college education if I cannot even afford the costs now, let alone in the future when my child enters college?”
In previous generations, if your family was fortunate enough to save for college, they simply put money in a savings account (or a mattress). Today, the government has established beneficial ways to save for college while simultaneously growing those assets. The primary college savings vehicle for most Americans is the 529 College Savings Account.
Saving for College with 529 Plans
The major advantage of owning a 529 account is the ability to save money for education, invest for appreciation, and withdraw the capital and earnings tax-free when used for qualified education expenses. Qualified higher education expenses include: tuition, room and board, books, etc. New provisions were recently enacted that also allow for qualified expenses of up to $10,000 per year to pay for K-12 expenses in addition to post-secondary and college expenses.
For example, if you have young children and establish 529 accounts, you can contribute to the account monthly, quarterly, yearly, or every few years. Your after-tax contributions will grow tax-free and you select investments to safely grow the portfolio. When the funds are needed for education expenses, the entire amount withdrawn, including appreciation, will be tax-free. If you start when your children are young, the tax savings on the earnings can be exponential compared to investing in a regular brokerage amount.
In addition, if you follow a disciplined program of regular monthly or quarterly deposits, you’ll also benefit from the power of Dollar Cost Averaging.
Gifting Strategy
Another advantage of the 529 College Savings Account is the gifting provision. As of 2019, the annual gift allowance to an individual is $15,000. Gifts over $15,000 to a natural person will be counted towards your lifetime exclusion amount, currently set at $11,400,000. If you are married filing jointly on your taxes, you can “split-gift” with your spouse and gift $30,000 per year to any individual.
The 529 College Savings Account is the only account in which you can lump 5 years of gifts to an individual in the same year. For example, if you would like to start a 529 account for your child and contribute the maximum amount for the current year, you could contribute $15,000 multiplied by 5 years, $75,000 total without any affect on the lifetime exclusion amount. A married couple filing jointly can start a 529 for their child with the maximum of $30,000 split-gift per year multiplied by 5 years, equaling $150,000 total. Keep in mind that if the 5-year lump sum contribution is utilized, then any gifts to that same person within those 5 years will be counted towards the lifetime annual exclusion.
A Downside…
One consideration to keep in mind is the penalty for withdrawals not ultimately used to pay for qualified education expenses, which is a 10% penalty in addition to ordinary income tax on the earnings. In this scenario, the after-tax principal contributions are returned in full to the account owner.
…or You Can Change Beneficiaries
One alternative to avoiding the income tax and 10% penalty is to change the beneficiary on the account to someone who can use it for education. The law is relatively lenient on this option, allowing you to change the beneficiary to any of the following:
- Natural or legally adopted children
- Parents or ancestors of parents
- Siblings or step-siblings
- Stepchildren
- Stepparents
- Nieces or nephews
- Aunts or uncles
- The spouse of any of the individuals listed above
- The spouse of the beneficiary
- First cousins
Use our team as a resource for information that maximizes college savings and asset appreciation, while minimizing taxes.
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NOTE: annual gift taxes and lifetime exclusion amounts shown are as of Sept. 2019 and are subject to change in the future.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.
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