By Tammy Trenta, MBA, CFP, CTC, CEXP, Founder and CEO – Family Financial
“Wait…I’m going to pay how much for college tuition?!”
While college has always been pricey, the cost to attend has grown astronomically over the years; tuition, room and board for the average four-year college has increased a whopping 180% since 1980 – and that’s including the adjustment for inflation. But recent price hikes in the neighborhood of 6-8% annually have left students saddled with egregious debt and prompted a renewed interest in college savings solutions.
So, what are 529 plans?
529 plans – named for Section 529 of the federal tax code – are education savings vehicles that invest in mutual funds and offer plenty of perks – like tax-free growth, and tax-free withdrawals for qualified education expenses. Although they’ve been around since the late 1990’s, complicated rules leave many scratching their heads. In this article, we will untangle the basics and review smart decision-making tactics for 529 account holders and the children who benefit.
How much should I save in a 529? (Or, will my child even go to college?)
This wildcard largely depends on your child’s individual interests and values system. We know the pandemic accelerated the adoption of online learning and highlighted the utility of remote education. Enrollment is on the decline, particularly among demographics with limited financial resources. And it may have permanently changed the college experience; for example, the need to commute has shifted drastically. If online classes continue to expand and campus sizes shrink over the next decade, it could impact the overall cost of education. If your children are very young, it’s difficult to accurately predict the amount you’ll need to save.
Regardless, the majority who decide to pursue a degree will need to save something; as things stand today, affordability is crucial. Given the potential for unpredictable tuition costs, affordability could also mean adjusting expectations and a shifted focus toward return on investment (ROI). This could mean balancing the invaluable experience of attending college with the practicality of the education received – for example, after comparing the ROI for a fine arts degree at an Ivy League school to a STEM degree from a state school – your child may come to a different decision.
These are factors to consider when setting that target number; while undersaving is not ideal, oversaving, and the tax consequences that come with it, is also something to avoid.
New rules add to the flexibility of 529 plans
Because we don’t have a crystal ball, the flexibility of 529 plans becomes even more attractive. Should your child decide to pursue a less expensive degree or forgo college altogether, you have the security of knowing beneficiaries can be changed to a qualified family member. This means that funds could potentially be used for someone else; by a sibling, first cousin, niece, nephew – or even for mom and dad to take a few classes. And theoretically, the money could roll over for generations to come.
Under the 2017 Tax Cuts and Jobs Act, the rules were expanded so 529s can now cover up to $10,000 for K-12 tuition expenses. Perhaps most notably, the recent SECURE Act 2.0 added the ability to roll over up to $35,000 of unused funds to a Roth IRA, per beneficiary.
It’s also a good idea to consider other savings vehicles to boost flexibility and reduce the chance that you’ll oversave for college. Remember, Roth IRAs also have tax-free growth and tax-free withdrawals. While the rules state you’ll need to leave the “growth”portion in the account until retirement – you can withdraw Roth contributions for any reason. You might also consider establishing a Uniform Gift/Transfer to Minors account (UGMA/UTMA). While these don’t carry the tax advantages of a 529 or a Roth, they have no contribution or withdrawal restrictions.
Be mindful of 529 ownership and financial aid eligibility
When a parent owns a 529 plan, it could impact their child’s eligibility for need-based financial aid – all of a parents’ assets are considered on the Free Application for Federal Student Aid (FAFSA). But when the plan is owned by a grandparent or other family member, those assets are not included the first year. It’s important to note that the distributions from the non-parent-owned 529 plan will be counted as untaxed income to the student on the FAFSA in subsequent years, potentially affecting their future eligibility for aid.
529 rules can vary state by state, so be sure to consult a financial professional as you embark on your savings plan.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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