In a recent post, we addressed a frequently asked question about determining where you stand with your overall investing. Today, let’s focus in on a subject near and dear to many investors’ heartfelt goals: funding their children’s higher education.
To help families save and invest for college, Congress created the tax-advantaged 529 plan in 1996, named after Section 529 of the Internal Revenue Code. Today, you’ll find that most states and some educational institutions offer 529 plans.
While there are often good reasons to establish a 529 plan for college savings, there also are many factors to be weighed and choices to be made along the way. Savingforcollege.com is a great resource to learn more, but here are two of the biggest questions we regularly encounter.
How do 529 plans work in the accumulation and withdrawal phases?
During accumulation – that is, as you’re saving for college – you contribute on a periodic basis and the money goes into the 529 plan of your choice. All 529 plan money grows federally tax-free. Your state may or may not give you an additional state tax break on 529 plan contributions.
Different plans offer different investments, and you typically don’t have to use your own state’s plan. When doing your due diligence, you may find a different state’s plan looks like an overall better deal. Or you might even be better off investing the money in your taxable accounts instead of typing it up for college costs. Bottom line, it’s worth taking the time to consider all available options before deciding which are right for you.
When you’re ready to withdraw money from your 529 plan, you typically reach out to the plan provider and request a check. Or you can usually set up an online account and have payments sent there. As long as the money is used to pay for qualified higher education expenses, the withdrawals will not be taxed.
Can I transfer the money to another child?
When you establish a 529 plan, you name a beneficiary for whom it is to be spent. What happens if that person is not going to be using it after all? Fortunately, you have some flexibility:
• You can change the beneficiary to another family member who is planning to attend college.
• You can keep the money in the account in case the beneficiary plans to attend graduate school at a later date.
• You can make yourself the beneficiary in case you want to go back to college, or if you might later change the beneficiary again to a different family member.
• Worst-case scenario, you can take out the money as a non-qualified withdrawal, paying taxes, plus a 10% penalty on the prorated earnings.
As you might expect, there are some caveats and qualifications on these rules of thumb … and sometimes the rules evolve over time. Whenever you are establishing or making changes to your 529 plan, we advise checking in with an investment professional to help you consider all the angles, crunch all the numbers and make optimal choices for you and your family.
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail email@example.com.
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