A pay-for-college primer
College-bound students go through a long process of researching colleges and deciding where they would like to continue their education. Shouldn't parents do the same when looking at how to pay for their children's college experience? In tough times, the thought of paying your children's way through college can sound daunting but it's something most hope to be able to do for their kids. People have found numerous ways to save up for higher education over the years, and one method is to set up a 529 college savings plan. Have you heard of a 529 college savings plan, and do you know how it works?
What is a 529 College Savings Plan?
A simple definition of a 529 savings plan is "a tax-advantaged savings plan designed to encourage saving for future college costs." 529 plans are also called "qualified tuition plans" and are sponsored by states, state agencies or educational institutions.
Types of 529 Plans
There are two types of a 529 plan that are offered nationwide; however, most states choose to offer one of the two plans.
1. Savings Plan - This plan allows the establishment of an account for the benefit of another party. Your cash is invested in investment options established by the plan. The total value will go up and down in conjunction with the performance of the investment options that you choose. The growth of these assets are tax-deferred and will be free from federal taxes if used to pay for qualified educational expenses.
2. Prepaid Plan - This plan allows you to pre-pay a portion or the full cost of an in-state public college education in the form of credits that are assessed at a value determined by the plan. This type of plan can also be converted for private college fees and out-of-state colleges. Please see the official program statement for the plan for additional details and limitations.
529 plans have many benefits. Two of the major benefits include flexibility and income tax advantages. 529 plans are great when it comes to flexibility. Virtually anyone can contribute to the plan on behalf of the beneficiary, including parents, grandparents and other extended family as well as friends. Additionally, investments can be used at a wide range of higher education institutions. Once the student is ready for college they can withdraw the funds to pay for qualified expenses at accredited colleges, universities and even technical schools.
529 plans have great income tax advantages. 529 plans have tax-deferred growth as well as tax-free qualified withdrawals meaning withdrawals used to pay for qualified higher education expenses are federally tax-free.
You might be wondering who has and keeps control of the account, especially once the student turns 18. The way these plans work is that the control lies in the hands of the account owner. If the original beneficiary decides not to attend college, then the account owner can choose to change the beneficiary to another family member, gift the investment or liquidate the account. However, earnings on withdrawals that are not used for qualified educational expenses are subject to federal income taxes and a 10 percent federal penalty tax as well as state income taxes.
How much can you contribute?
Typically, account owners can contribute up to $13,000 annually or $26,000 for married couples filling jointly without incurring any gift taxes. In addition, 529 plans offer the opportunity for 5 year accelerated gifting which permits a single person to make an upfront contribution of $65,000 ($130,000 for a married couple) per beneficiary without incurring any gift tax or penalties provided certain conditions are met. A tax advisor should always be consulted when considering an investment in a 529 college savings so that you fully understand all of the associate tax benefits and implications.
Most state plans provide for high contribution limits. "This allows clients to add to their investment until the account value reaches the state-mandated maximum amount."
When considering if a 529 college savings plan is right for you, make sure you don't lose sight of your other financial goals. Follow the lead of college-bound students. Do your research and consult with a financial advisor on what plan would be best for you.
To get more basic information on 529 Plans you can visit www.sec.gov/investor/pubs/intro529.htm in addition to consulting your financial advisor.
Julie Stone, CIMA® is a Financial Advisor with the Global Wealth Management Division of Morgan Stanley Smith Barney in Denver. She has been building solid portfolios for over 22 years.
The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, or its affiliates.