• May 2010

Do 529 Plans make the grade?

By Brock Jolly
The College Funding Coach

Over the past decade, Section 529 plans have become the primary college funding vehicle favored by most families. This month is an appropriate time to focus on this tool, because May 29 (= 5/29) is National 529 College Savings Day, sponsored by the College Savings Plans Network.

Statistics show that most parents are familiar with Section 529 plans, yet only about 12% of parents have actually invested in these plans, according to InvestmentNews.

This may be a blessing in disguise because many parents who invested in Section 529 plans lost significant sums of money with the recent decline of the financial markets—money that was designed to be spent in the very near future—but is now gone.

As with any financial product, Section 529 plans have advantages and disadvantages, so it is imperative that parents evaluate their options before diving headfirst into the ocean of college savings alternatives.

Understanding the Basics

Most of us are keenly aware of 401(k) plans. Just as 401(k) is a section of the IRS Tax Code, Section 529 is the section of the Code that deals specifically with college savings plans.

There are two basic types of plans: Prepaid tuition plans and savings variety plans. Each state sponsors at least one Section 529 plan, and many states have multiple options.

Federally, and in most states, the growth of the portfolio is tax-deferred, and distributions are tax-free as long as they are used for qualified higher education expenses, including tuition, room and board, fees, books, computers, supplies, and such.

In addition, some states allow tax deductions for contributions to Section 529 plans.

For example, Virginia offers state residents a $4,000 per beneficiary, per plan, per year tax deduction. If a contributor puts in $4,000 in a given year, she may carry-forward those deductions to tax returns in a subsequent year.

Some states, like Indiana, offer state residents a 20% tax credit, up to $1,000. Clearly, the tax-deferred growth and tax-free distributions make this a savings plan worth considering.

What is the difference between saving with a tax-free account like a 529 Plan versus saving with a taxable account?

Generally speaking, the savings-variety 529 plans are run by mutual fund families, and can be purchased through a financial advisor or directly through the state. In addition, some states provide options with guaranteed investment options sold by banks or other financial institutions.

529 Plan Advantages

In addition to the federal and state tax advantages, 529 plans are designed to be flexible savings plans with a variety of investment options. In most cases, 529 plans encourage early and consistent savings by offering an easy, affordable, and convenient way for families to save for college.

Additional benefits include:

• Unlike UTMA or UGMA accounts, the account holder retains control of the assets within the program regardless of the beneficiary’s age.
• Most plans have very low minimum monthly contribution limits.
• The beneficiary can be changed at any time to another member of the beneficiary’s family.
• Money can be used at virtually any accredited college in the country.
• Assets within 529 plans are generally protected from bankruptcy.
• Account owners can make a lump sum contribution of up to $65,000 per beneficiary or $130,000 if married filing jointly and avoid incurring a taxable gift on this amount by electing to use five years of the annual gift tax exclusion all in one year. After utilizing this provision, the annual exclusion cannot be used again for the same beneficiary until the five year period has passed. Should a donor die within those five years, a pro-rata amount of the gift will revert back to their estate and be treated as a taxable gift

529 Plan Disadvantages

With the prepaid tuition 529 plan, the disadvantages are fairly clear—if a student attends any school other than a public, in-state school, they generally will receive back the money that was originally paid into the plan, plus a small amount of interest, or the average of the cost of tuition at all in-state public schools in the state in which they established the plan.

If a family is reasonably certain that their children will attend an in-state public school, and they will stay in the state in which they currently live, prepaid plans are a great option.

However, in today’s fast-paced world, families don’t always stay in one place for a long time.

In addition, if a child is accepted to a prestigious private school, does the ownership of the prepaid plan mean that the parents have minimal alternative resources with which to pay for school? And even if the child does receive back the average of the in-state cost of tuition, this is generally a drop in the bucket when compared to out-of-state or private school costs.

Along the same lines, the 529 plan can be a detriment when it comes to qualifying for financial aid. If a family is eligible for aid, the value of the 529 plan generally is includable as a parental asset for purposes of calculating the Expected Family Contribution (EFC) amount—the amount that determines how much the schools believe a family should be able to pay each year.

Finally, because 529 plans are generally tied to the stock or bond market in some way, they are generally volatile, and can lose money. What happens if a family’s prized college funding asset—the 529 plan—suddenly becomes a “229 plan” in the year before your child heads off to school?

The Bottom Line

So do the pros outweigh the cons? As with any investment, it is imperative that you evaluate all of your options.

Often, a combination of strategies makes the most sense. We’ll explore these options in future issues of “Be Inkandescent Magazine.”

The value of higher education is becoming increasingly important in today’s society, and paying for it has become more and more difficult. With dollars already stretched thin in today’s economy, it is important that a family create a comprehensive financial plan with contingencies for all of the curveballs that can come your way when it comes to planning and paying for college.

I think we can all agree on one thing—the cost of a four-year college education will not be getting less expensive any time soon. Whether you determine that a Section 529 plan is right for your family is an important decision; but what is more important is that you do something. Even if you’ve got young children, the good news is that you’ve got time on your side; but the bad news is, well, you’ve got time on your side.

I’ll be back next month with more thoughts. Until then, here’s to your financially-savvy future.


About Brock Jolly

Columbus, Indiana native Brock Jolly has been a financial planner at Capitol Financial Partners since 2001. He holds a certification in Long-Term Care (CLTC) designation, and since 2006 has had a Certified Financial Planner (CFP®) designation from the American College in Bryn Mawr. Brock was a Qualifying Member of the prestigious Million Dollar Round Table that year.

Brock hosts adult education to help families save for college. His course, “Little Known Secrets of Paying for College,” teaches parents how to finance a college education without jeopardizing their own retirement savings.

For more information, visit www.greenbackstrategies.com. Contact Brock directly at bjolly@finsvcs.com.

Brock Jolly is a registered representative of and offers securities, investment advisory and financial planning services through MML Investors Services, Inc., member SIPC. Supervisory Office: 1410 Spring Hill Road, suite 425, McLean VA 22102.