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An insider's guide to 529 plans


As a parent or grandparent, wishing to help your child (grandchild) pay for their college education, funding a 529 College Savings Plan is an excellent approach . While some of the benefits of the 529 College Savings Plan are well known, such as paying no federal or state taxes on fund gains used for qualified college expenses, other advantages also exist.

A 529 College Savings Plan requires strict adherence to the rules to receive the tax advantages and avoid any penalties. If you are questioning whether a 529 College Savings Plan is the proper approach for your child’s or grandchild’s educational saving, here are some less known advantages as well as some of the pitfalls of a 529 Plan.


1) Estate Tax Savings: Annually, an individual may contribute $14,000 and a couple may contribute $28,000 to each 529 College Savings Plan beneficiary. In a single year, an individual or a couple may provide the next five years worth of contributions, allowing for single year contributions of $70,000 for an individual or $140,000 for a couple, for each beneficiary. Wealthy grandparents may contribute $140,000 for each grandchild’s education, removing the total contributed amount from their taxable estate.

2) Immediate State Tax Saving: If you live in Colorado, contributions to the Colorado CollegeInvest 529 Plan are deductible immediately on Colorado income taxes. Even if your child or grandchild is already in college, you may contribute funds to the CollegeInvest 529 Plan that will be used for their current or remaining college expenses. Even these contributions can be deducted from the current year’s Colorado income tax.

3) Changing Beneficiaries:. If a child or grandchild decides not to go to college or earns a scholarship, the plan donor may change the beneficiary to another child or grandchild, or even to a niece or nephew. After all of the children finish college, if funds remain, the donor or their spouse may become the beneficiary, and the remaining funds can be used for their higher education expenses.

4) Reclaiming Contributions: The donor of a 529 College Savings Plan may reclaim their gift at any time. If the donor’s financial circumstances change, the contributed 529 Plan funds may be reclaimed, without penalty. Only the gains, since the initial contribution, are taxed and receive an additional 10% tax penalty. This “safety valve” feature is unique for gifts made to 529 College Savings Plans.

Potential 529 Plan Pitfalls

1) “Qualified” Educational Expenses: All 529 College Savings Plan withdrawals must be “qualified” educational expenses to avoid taxes and penalties. Tuition, books, supplies, college fees, equipment and special needs services are considered qualified expenses. Room and board is only “qualified” if the student is enrolled at least half time in a college or graduate school curriculum.

2) Payment timing: 529 College Savings withdrawal must occur in the calendar year in which you are paying expenses. Funds withdrawn in the year prior to the year in which the expenses are paid could be subject to taxes and penalty.

3) Fix mistakes fast: If too much is accidentally withdrawn in a year, you may roll over the excess withdrawal into a different 529 account within sixty days, without any penalty. Only one rollover per year is allowed.

4) Federal tax credits: If one is eligible, the American Opportunity Tax Credit provides a credit for up $2,500 per student, per year. For the full $2,500 tax credit, the tax payer must pay $4,000 of college expenses. If the American Opportunity Tax Credit is used, reduce the 529 College Savings Plan withdrawals by the amount claimed.

5) Scholarships: Deduct any scholarships from 529 College Savings Plan withdrawals. If the scholarships occur after making your withdrawals, income taxes on the gains of the excess withdrawals are due, but not the 10 percent penalty.

The advantages of a 529 College saving plan are significant, while “pitfalls” are easily avoided if you know the rules.

The ideal time to fund a 529 College Savings Plan is when your child or grandchild is a baby. However, even if the student has already begun college, Colorado state Income tax incentives may make a 529 College Savings Plan the best vehicle for paying the student’s college education.

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Wayne Farlow

Wayne Farlow is the founder of Financial Abundance, LLC, a Registered Investment Advisor firm.  He is a Certified Financial Planner (CFP®), focusing on Retirement Planning, Investment Management, Small Business Owner Planning and Sudden Wealth/Inheritance Planning.  His book, “Financial Abundance Guide,” is available free at www.farlowfinancial.com .  He can be reached at wayne@farlowfinancial.com or at 303-554-0309.

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