Weekend Read - Saving for college in a 529
I take pride in personally crafting each of these emails. Unlike many others in the industry who rely on prewritten content, I write these myself from scratch. My goal is to boil down complex concepts and share relevant news in an easy-to-understand format. I hope you find them both informative and enjoyable.
As you may know, college is expensive, and over the last decade, costs have risen an average of 4+% annually1. We could spend hours discussing whether this is sustainable and wax poetically about the value of a college degree, but that’s a conversation for another time. Today let’s explore what you can do to help your kids/grandchildren graduate with as little debt as possible.
A 529 is an investment account designed for college and one of the best ways to do it. The way it works is you open up the account as the owner and designate a child as the beneficiary of the funds within. Before you get started, there are some things you're going to want to know.
Which 529 is right for me?
More than 30 states offer tax benefits for contributions to a 529 plan. If your state provides a tax break, they will typically require you to sign up for the state specific 529 plan they offer in order to claim it. However, if the tax benefit is minimal or nonexistent, you might want to explore other state plans with better investment options or lower fees. If you’re wondering whether or not your state offers tax benefits here’s a handy link that lists them all.
Contributions
Let’s start by discussing the money you’re going to need to save in order for this to work. One of the good things here is that anyone can contribute to a 529 account. The maximum someone can donate to an individual in a given year without having to worry about taxes is $18,000. That's per person. So, mom and dad can contribute $36,000 in 2024 to a child. Also, if you’d like to drop a lump sum in there, you can contribute 5 years worth at once2.
How much can I contribute?
College is expensive. The national average for a state school is $45,708 and $58,628 for private school per year3. It’s hard not to digress into a conversation about how the rising cost of college has already become an issue. We already have over $1,730,000,000,000 in college debt and no there are no extra zeroes in there. I counted. At current growth rates, if you had a child today, by the time they were 18 and ready for school, it would cost $94,211 for a year at a state school and $120,842 per year at a private university.
My calculations say that if you can earn 8% on your investments[1], you’d need to contribute roughly $8,640 per year for state school and $11,088 a year for private school. This doesn’t consider a slew of things like scholarships, financial aid, and graduate school all of which can have a considerable impact on school costs for better and worse.
Also, I can’t underemphasize the benefit of putting away a lump sum in the beginning. You get a significant benefit by putting the money to work at the outset as opposed to making monthly contributions over time.
What can I use the funds for?
A Qualified Expense is a list of things the IRS says you can use 529 funds for. Here’s a brief cheat sheet that should give you the idea3.
Tuition Covered
Room & Board Covered but if your child is living off campus in housing not provided by the school, then only the expense of what the school would have provided would be eligible
Meal Plan Covered
Books The required reading list is covered
Technology If needed for school its covered i.e. laptops yes, smartphones no
Does not qualify Insurance payments, health club fees, travel costs, student loans (up to 10k)
Also, the Secure Act changes added k-12 as qualified sources of 529 funds. However, because the time frame for this is so short between when you’d save it and need it, it is much less of a compounding growth/tax benefit. For k-12, a lot of the benefit comes from if your state offers a tax deduction. That’s not to say that there’s no compounding growth/tax benefit, its just reduced from a college savings goal.
How should I invest it?
Also, if you’d like to get ahead of the game, you are able to open a 529 prior to the birth of the intended beneficiary. You would just open it up with you as the owner and beneficiary and then when the child is born change the beneficiary to them. This gives you an opportunity to extend the time the investments have the potential to grow and compound.
On the contrary, the shorter the time until the money is needed for school, the less the benefit of a 529. The rationale here is that the investments need time to grow in order to enjoy the tax benefits. Additionally, the effects of compounding are reduced and the less time you have, the more you’d need to save to meet your funding goals. This might mean that as you get to the shorter time frames(less than 10 years), the investment strategy might need to be less aggressive as you will be needing it sooner and don’t have as much time to make up for market volatility. That being said, there are some calculations that can be done to determine how much to save and if it makes sense for if you find yourself closer to the college years.
Taxes
Taxes are the largest benefit you’ll enjoy by investing in a 529 plan. Any money you invest in one grows without tax. That money can then be used for qualified expenses tax-free. It’s hard to understate how important a benefit this is. Let’s consider two hypothetical scenarios. Scenario one, we put $50,000 into an account and invest it, over the next 18 years it grows to $200,000. Now let’s say we need access to all the money to pay for school. We have $150,000 in growth taxed at 15% because that’s the long-term capital gains tax rate which in this case results in $22,500 for Uncle Sam. Let’s consider a 529 now. The same $50,000 growing to the same $200,000 can be used in its entirety without any tax whatsoever. Every single penny goes straight to the education, like intended. Also, as we get closer to needing the money and we want to make our investments more conservative we don’t have to worry about the tax ramifications for any changes we make. Lastly, several states offer tax deductions for contributions made into a 529.
Beneficiaries
Beneficiaries are an important thing to be aware of when it comes to a 529. The way 529’s work is when you open up an account you must elect an owner and a beneficiary. The investment selection is directed by the owner and the assets are used for the benefit of the beneficiary. The important thing to be aware of here is that you can only have one beneficiary on a 529 at a time. So, if you’re going to have multiple children in school simultaneously you won’t be able to use the funds from one 529 account for both kids. However, you can change the beneficiaries on a 529, so if you have one child who finishes school and there are extra funds left in the account, you can change the beneficiary to your other child to use the rest. Also, you can change the beneficiary to any family member including yourself, your spouse, stepchildren, nieces, uncles, and first cousins4.
Leftovers
What happens if there is money left over and no one to use it. This can happen for a variety of reasons. For example, maybe the child doesn’t go to school, or they get a great scholarship and don’t need the money, or perhaps they go to a trade school for two years and only use up half. This is where a 529 can be a little painful. In exchange for the benefit of tax exemption, the government says that any money not used as a qualified expense is subject to both income tax on the gains as well as a 10% penalty. So, you can easily lose 1/3 to the government in the process of trying to liquidate the leftovers in an account.
Recent law changes have added the option of unused funds to be rolled over into a Roth IRA. However, there are a slew of rules and restrictions that are rather new and unclear that have to be met. They are:
- The 529 account must have been open for more than 15 years
- The eligible rollover amount must have been in the 529 account for at least 5 years
- The annual rollover limit is subject to Roth IRA annual contribution limits ($7,000 for 2024; $8,000 for individuals age 50 and older)
- There is a lifetime rollover limit of $35,000 for each 529 account beneficiary
- Rollovers can only be made to the Roth IRA account owned by the named 529 account beneficiary
Conclusion
In summary, a 529 plan can be a powerful tool to help your children or grandchildren avoid the burden of student loan debt. Its potential for growth and tax-free withdrawals for qualified expenses make it a very attractive product. As with any investment, it's essential to evaluate your family's specific needs, the projected costs of education, and any tax benefits your state may offer. If you're unsure whether a 529 plan is the right fit, or if you'd like to explore other options, feel free to reach out. I’m happy to discuss your situation and help you make the best decision for your family’s future. Also, there are other accounts that can be used for kids that do not require the funds to be used exclusively for college. I’m happy to discuss those with you too.
If you’ve only recently joined my email list, you’ve missed out on many insights and updates that I've been sharing each week. Be sure to visit my blog to explore past content that you might find valuable.
1https://educationdata.org/average-cost-of-college
2https://www.savingforcollege.com/article/maximum-529-plan-contribution-limits-by-state
3https://www.savingforcollege.com/article/what-you-can-pay-for-with-a-529-plan
4https://www.savingforcollege.com/article/how-to-change-the-beneficiary-on-your-529-plan
The information and data contained in this report are from sources considered reliable, but their accuracy and completeness is not guaranteed.
Investors should consider many factors before deciding which 529 plan is appropriate. Some of these factors include: the Plan’s investment options and the historical investment performance of these options, the Plan’s flexibility and features, the reputation and expertise of the Plan’s investment manager, Plan contribution limits and the federal and state tax benefits associated with an investment in the Plan. Some states, for example, offer favorable tax treatment and other benefits to their residents only if they invest in the state’s own Qualified Tuition Program. Investors should determine their home state’s tax treatment of 529 plans when considering whether to choose an in-state or out-of-state plan. Investors should consult with their tax or legal advisor before investing in any 529 Plan or contact their state tax division for more information. Steward Partners Investment Solutions, LLC does not provide tax and/or legal advice.
529 Plans are sold by Disclosure Document. Investors should carefully consider the investment objectives and risks as well as charges and expenses of 529 Plans including the underlying portfolios before investing. To obtain a Disclosure Document, contact your Wealth Manager. The Disclosure Document contains this and other information about the investment. Read the Disclosure Document carefully before investing.
AdTrax 6982904.1 Exp 9/25
[1] Hypothetical returns do not represent the performance of any particular security or portfolio.