Jan. 25, 2018
When you are investing, what you don’t know can hurt you. In the case of 529 college savings plans, what you don’t know can end up negatively impacting your child. By not taking advantage of a 529 college savings plan, you can miss out on an array of benefits that can help you create a better plan for your child's college education.
These plans are still relevant for people who do not have children. As aunts and uncles, or relatives of the next generation, many people are in the position to support the college education of another person at some point. For anyone interested in learning more about 529 plans, here are answers to five commonly asked questions.
Answers to 5 Most Commonly Asked Questions
1. Question: Do I have to have a child in order to open a 529 account?
Answer: Although it’s true that you cannot open up a 529 account in an unborn child’s name, it is entirely possible to open up a 529 account and name yourself, or your spouse, as the beneficiary. By opening up an account prior to the birth of your child, you are able to jump-start your savings and stash away a greater amount of money prior to your child’s enrollment in college. Once your child (or niece/nephew) is born, you can then change the beneficiary on the 529 plan to him or her.
2. Question: Do I have to open the 529 plan offered by the state I live in?
Answer: You have the ability to invest in any state-sponsored 529 plan. That being said, evaluating your options can be bewildering. Some, but by no means all, states offer residents tax advantages, such as deductions or credits. When trying to decide which plan works best for you, a great resource to reference is Nerd Wallet’s database of 529 plans.
3. Question: Will I lose the money I've saved in a 529 account if the beneficiary doesn’t use it all while in college?
Answer: The money in a 529 account you opened is still yours if the beneficiary on whose behalf it was established does not need it. The money can still be used for post secondary education for another beneficiary, or for yourself.
Remember, the money in a 529 account ultimately belongs to the owner of the account, not the beneficiary. You can keep the money invested in the account in anticipation of the beneficiary going to graduate school. And, as mentioned above, you can always change the beneficiary on the 529 account to another family member, whether it is a younger sibling, niece, nephew or grandchild. Even when your child turns 18 (or 21 in some states) and is legally considered to be an adult, the money saved in a 529 account is yours as the account owner.
Additionally if you, as the account owner, need the money in a 529 account for reasons unassociated with higher education, rest assured that the money is still yours. But be aware that you will pay a 10% penalty, pay ordinary income taxes on the federal level, and will have to pay back the state tax deduction (if received) when you withdraw the money. It’s worth noting, however, that the taxes you pay are only on the earnings portion of the money invested in the plan.
One important caveat on the above paragraph is that if your child receives a scholarship and doesn’t need all of the money in a 529 account, you can withdraw an amount equivalent to the scholarship without incurring the 10% penalty, although you will still have to pay taxes on the earnings portion of the money you take out.
4. Question: Will savings in a 529 account limit financial aid?
Answer: A parent-owned 529 plan is treated as an asset for financial aid purposes and is counted up to 5.64% as part of the Expected Family Contribution (EFC) amount used to determine financial aid eligibility. The higher the EFC, the lower amount of financial aid a university will provide.
Please note, however, that this impact is potentially small and should not severely limit financial aid for your child. These plans are still a great way to save for your child’s education, regardless of the effect on financial aid. This topic can be difficult to parse, so it is understandable to have concerns about how a 529 plan can impact a child’s eligibility for financial aid. In some situations, it can be hard to discern whether or not a 529 plan will end up being more helpful or harmful for a student that may require financial aid.
5. Question: Can savings in a 529 plan be used to pay for something other than college education expenses?
Answer: The tax recent reform bill expanded the scope of 529 plans, and families can now save for K-12th grade expenses, in addition to college expenses. Up to $10,000 can be used for elementary and secondary schools expenses per year, per student. This is a huge boon if you plan to send your child to private school prior to college as the distributions, similar to those for college expenses, can be withdrawn tax free, thereby avoiding having to pay capital gains taxes on the growth of the money in the 529 account.
Thoughtfully considering how best to save for your child’s education can make an enormous difference once the first tuition payments comes due and ultimately, in what college ends of costing.
Disclosure: The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a non-qualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.