In 1996 — thanks to Congress — Internal Revenue Code 529, which is also known as a “Qualified Tuition Program,” was added to tax law. I’ll refer to it as “529” or “529 plan” from here on out, because I’d like to share with you the financial value of these plans — and how they can help you send your kids or grandkids on a path to educational success.
What is a 529 plan?
There are two types of 529 plans, and both plans offer federal tax benefits, with the goal being to save for education related expenses. While the contributions themselves are not deductible, funds taken from these plans to pay for qualified education expenses are not taxed.
Qualified expenses include such things as books, room and board, tuition, mandatory fees, and so on. Pre-paid programs will typically pay directly to the institution for tuition.
What are the two types of 529 plans?
First, there is the pre-paid college program. This plan will lock in the price of tuition at all eligible colleges and universities, but not all states offer this. They usually require that either the owner or beneficiary are a resident of the state. A variety of options are available for this first type of 529. Florida, for example, offers two-year plans, four-year plans. “2 + 2” plans, and more. There are even dormitory options! The cost of these plans can be paid in a lump sum or in monthly payments. The cost and payments are determined by using the age of the beneficiary and the type of plan selected.
The second type of 529 plan is the college savings plan. This savings plan offers a variety of investment options. The options available will depend on which state plan you select. Some states offer additional tax incentives for using the plan associated with that state. If you live in a state that does not have a state income tax, this is not an issue. There are additional options available as well with many of these savings plans, such as changing beneficiaries to another child or even to yourself.
What happens if the beneficiary doesn’t go to college?
Even if your child or grandchild – or whomever is the beneficiary of the plan – doesn’t go away to college, there are still many other available options. Many institutions also qualify in 529 plans.
What other kinds of institutions are covered by a 529 plan?
These include, but are not limited to: trade schools, technical programs, art and music schools and even more. Generally speaking: if the institution receives financial aid, the cost will likely qualify. Pre-paid programs vary on this and you should consult a financial advisor and tax advisor to make sure. In the worst-case scenario however, you’ll still get back the money paid in — minus a fee (which in many if not most cases is minimal.)
How much can I contribute to a college savings plan?
Another question that I’m asked often is: how much can be contributed to a college savings plan? This also varies based on the plan itself.
The annual contribution amount is the same as gifting limits, or currently $15,000/year. Both parents can contribute which brings the amount up to $30,000/year. The funding strategy known as “super funding” allows each parent to add five years of funding at once — meaning a single contribution of $150,000.
If you use this strategy, you’ll need to file appropriate forms so the IRS knows exactly what you’re doing. If this is done in year one, you can’t make additional contributions until year six. Finally, once the plan’s maximum has been met, no further contributions can be made.
Which 529 plan type should I choose?
In the end, this is up to only you! While the savings plan option has greater flexibility than the pre-paid option, don’t immediately discount the value of pre-paid plans.
If you and your financial advisor are willing to do a bit more work, consider using a combination of both plans! If you’re reasonably sure that your chosen beneficiary will attend one of the institutions covered by the plan, the pre-paid portion can act as a surrogate inflation-hedged bond.
Let’s say you make monthly payments for four years of tuition at a state school. Think of this as the bond component of your asset allocation that offers a guarantee of four years of tuition. Then, depending on the beneficiary’s age, invest in stock mutual funds in the savings plan portion. Keep in mind that while these plans allow you to change mutual funds, the frequency at which changes can be made is limited.
Here are some helpful links regarding 529 plans (no relation to Allen & Company):
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Investing involves risk including loss of principal.
Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.