Are You Concerned About Investing in a 529 Plan?

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This past weekend was 5/29 or 529 day. It has been my experience that 529 plans are often viewed with trepidation. Whether its questions about how it will affect financial aid or the ability to use funds for out-of-state universities, clearly there is a lot of doubt about the proper use of a 529 plan. While there is no one financial tool that works in every case, here are a few responses for the most common 529 plan concerns:



Concern #1: Money in a student’s 529 account will affect financial aid eligibility

Although 529 assets are included in the calculation for financial aid , the good news is that an account owned by the parent is considered a parental asset so its impact would not be as significant as it could have been if it were the child’s asset. That said, there has been a concern about non-parental distributions (e.g., 529s owned by grandparents) being treated as untaxed income to the beneficiary. For that reason, we have suggested that non-parents wait until the child’s junior year to pay for the education with those funds. Now even that concern is set to change in 2023 .

Concern #2: I am required to use my own state’s 529 plan, and the funds must be used toward a college in my own state

This is a common myth that I often hear in workshops, but the simple truth is that you may use a 529 college savings plan (but not necessarily the prepaid version of a 529) account from any state, and your child may attend college in any state and still receive the federal tax benefits. However, some states offer state income tax benefits to residents who use the program from their own state. Even better, residents of states such as Arizona, Kansas, Minnesota, and Pennsylvania are eligible for state income tax benefits regardless of which state’s plan they use.

If you are in a state without a state income tax, check your local plan to see if you may qualify for other savings incentives, including free money in some cases. If you are in a situation where you may not qualify for a tax incentive or other benefit, consider shopping all of the state plans based on their investment performance and fees using resources like SavingforCollege.com or Morningstar .

Concern #3: If my child doesn’t go to college or I use the money for something else, I’ll get hit with a tax penalty on everything I’ve saved

Obviously, the reason we put money into a 529 account is because we hope to use it to pay for qualified higher education expenses , but if we don’t, only the earnings will be subject to income taxes and a 10% penalty. One change that occurred several years back is that the definition has expanded to include certain elementary and secondary school expenses up to $10,000. If there is no chance the original beneficiary will use the funds, see if you can rename the beneficiary to someone that will likely use the funds for qualified expenses. You can change the beneficiary to a relative of the original beneficiary including a sibling, the child of a beneficiary or even a parent..

Concern #4: I will have to pay a tax penalty if my child is awarded a full ride

If your child is fortunate enough to receive a scholarship , you may be eligible to withdraw up to the scholarship amount without penalty. Just remember that if the scholarship is tax-free the amount withdrawn from the account that is attributed to earnings may be taxed as ordinary income. For those of you that may be planning to withdraw funds from a 529 account this year, check out Joseph Hurley’s article on 529 withdrawal traps to avoid .

Alternatives

Of course, you are not required to use a 529 plan to save for education. It is very common to see parents invest the funds in their own name, Coverdell education savings accounts (Coverdell ESA), or Uniform Transfers & Gifts to Minors Act (UTMA/UGMA) accounts to save in the child’s name. Just like the 529, these alternatives have their pros and cons. I would suggest meeting with an advisor or financial coach to discuss which tool may fit. Just be sure to not throw out the 529 without reviewing the facts listed above.

By Cyrus Purnell, Contributor

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Schultz Financial Group, Inc.

Wealth Advisors
Office : (775) 850-5620
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