By Jeffrey J. Brown, MD, MBA, CFA®, CFP®
It’s tempting to put off saving for college, especially if your children are young, but as anyone with kids knows, the days are long but the years are short. Before you know it, they’ll be visiting colleges and filling out applications. In other words, it pays to plan ahead. Have you started saving for your child’s future education costs? If not, here are some important benefits to consider when thinking about paying for college with a 529 plan.
Why Do I Need To Save For College?
Tuition rates have increased at a faster pace than many other expenses over the past decade, rising an average of 1.8% per year for private schools and 1.9% for public colleges. (1) As with retirement savings, starting early and harnessing the power of compound interest is the key to a successful college savings plan. With that in mind, let’s discuss six important benefits of using a 529 plan to save for college.
The Benefits Of A 529 Account
A 529 plan is a state-sponsored education savings account that allows earnings to grow tax-free. There are two categories of 529 plans: prepaid tuition plans and college savings plans.
Prepaid plans let you pay future tuition costs at today’s prices, which can be enticing. On the other hand, college savings plans have no age or income restrictions and allow you to save anywhere from $235,000 to $529,000 per child, (2) and then use these assets tax-free, for qualified education expenses.
1. Tax-Free Earnings
You do not have to pay taxes on earnings in a 529 as long as the funds are used for qualifying higher education costs. (3)
2. State Tax Deductions
Many states offer state income tax deductions for contributions made by residents of their state, but you should check to be sure. For example, California does not provide a deduction, (4) but Missouri taxpayers may deduct up to $8,000 per year ($16,000 if you are married filing jointly) of your 529 plan contributions. (5)
3. Plan Flexibility
One of the benefits of 529 plans is that you can transfer the funds to another family member or relative if your child does not end up using the assets.
Contributing to a 529 plan is not a privilege reserved for the parents of the beneficiary. Anyone can contribute to your child’s college savings plan, including grandparents or other family members.
529 plans can be a useful estate planning tool for grandparents interested in helping to fund a child’s college expenses. An individual can contribute up to $15,000 per year to a grandchild’s 529 plan free from federal gift taxes. He or she can also accelerate the gifting schedule by making a lump-sum contribution of $75,000 to a grandchild’s 529 plan in the first year of a five-year period ($150,000 for a couple). To help illustrate the wealth transfer benefits of this approach, a grandparent with five grandchildren could immediately remove up to $375,000 from his or her taxable estate by contributing to five separate 529 plan accounts.
4. Alternate Ways To Use The Money
As of 2017, 529 account holders can use up to $10,000 annually on pre-college educational expenses, such as K-12 private or religious school tuition. This includes tuition expenses at private, public, and religious K-12 schools. And thanks to the SECURE Act of 2019, you can also use your 529 savings to pay for apprenticeship fees, homeschooling, or up to $10,000 of qualified student loan repayments (including those for the 529 plan recipient’s siblings). (6)
5. Parental Control Of Funds
There is no need to worry about your teenager mishandling the funds because you, the parent, remain in control of the assets. The child that you are saving the money for is the named beneficiary of the account, but you are still the account owner and they cannot bypass you to access the funds.
6. Financial Aid Is Still Possible
Your child’s 529 account does factor into the Free Application for Federal Student Aid (FAFSA) calculation, but since the account is in the parent’s name, only 5.64% of the assets count, meaning the impact on your child’s eligibility for financial aid is limited.
Ready To Open A 529 Account?
We would love to answer your questions, explain your options, and help you determine the best path to reach your goals for college savings. Please feel free to contact us any time with questions about college savings or any other financial planning topic. Schedule an introductory phone call online or contact us at (314) 434-4750 or contact@shearwatercapital.com to get started today.
About Jeff
Jeffrey Brown is principal and chief investment officer at Shearwater Capital, LLC, a fee-only fiduciary financial advisory firm helping physicians and their families attain financial security using a scientific, evidence-based approach. Jeff has been a practicing radiologist for over 30 years and is currently chair of the Department of Radiology at Saint Louis University School of Medicine. He earned his bachelor’s degree from the University of California, Irvine and his medical degree from the University of California, San Diego. He has been named one of St. Louis’s Top Doctors every year since 2011 in St. Louis Magazine. Jeff saw a need for physician-tailored financial services and earned an MBA from Washington University in St. Louis, going on to found Shearwater Capital, LLC with fellow MBA classmate and radiologist, Eric Malden. Jeff is a Chartered Financial Analyst (CFA®) and CERTIFIED FINANCIAL PLANNER® (CFP®) practitioner. Learn more about Jeff by connecting with him on LinkedIn.
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(1) https://research.collegeboard.org/trends/college-pricing/figures-tables/growth-in-published-charges