Financial Planning

The 411 on the 529

For those interested in saving for college, here is some information on 529 plans.

We just passed 5/29, which means you may have just missed out on some of this year’s National College Savings Day 529 promos. Sorry. Though you may have to wait till next year to try and win $1,529, learning about 529 plans could still be worth your while—especially if you are looking for ways to save for a youngster’s future college costs.

What Are They

Established by Congress in 1996, 529 plans are state-sponsored, tax-advantaged vehicles designed to help folks plan and save for college. Plans vary by state, but you aren’t restricted to those in the state you live in or the state you hope junior goes to college. You can shop around and enroll directly with another state’s 529 plan manager or find one through a financial professional.

The common savings plan works like a Roth 401(k) or IRA, in which you invest after-tax contributions in the available investment options. Plans usually offer some broad options, like age-based or static asset allocations. Age-based portfolios change their asset allocation over time (usually a higher equity allocation at the start before shifting to more fixed income the closer you get to the projected college date). Static portfolios keep the asset allocation the same—e.g., invested in an offered fund or strategy.

While there is no official IRS-mandated annual contribution limit, there are maximum aggregate limits that vary by plan. Per federal law, 529 plan balances can’t exceed the expected cost of the beneficiary’s qualified education expenses.[i] Folks should also consider the applicable tax implications—make sure to consult with your tax advisor for more.

Benefits and Drawbacks

One of 529 plans’ biggest benefits is their favorable tax treatment. You contribute post-tax money, but capital gains and withdrawals are federal tax-free—similar to a Roth IRA—as long as the money is used for “qualified higher education expenses.” This includes tuition, fees, textbooks and computers.[ii] Starting this year, up to $10,000 from a 529 can be applied to K-12 tuition. Further, more than 30 states offer residents full or partial state income tax deduction or credit for 529 plan contributions (though most require residents to use their home state’s plan). 529 plans are also easy to start up: Anyone can open one and contribute to it, regardless of income level. You can enroll in some plans for as little as $25 and can contribute what you want, when you want.

On the drawback side, your investment options may be limited. You have to do your due diligence to ensure you are invested properly—not just in regards to fees but asset allocation too. Many options rely on the premise that risk tolerance should determine asset allocation. While comfort is important, you may also need a certain amount of growth. In our view, that requires an appropriate equity allocation, which depends on the situation. For example, 100% equities may not be suitable if the beneficiary is a high school senior planning to make a withdrawal next year. However, it could be appropriate for a family with a newborn that doesn’t plan to tap the funds for almost two decades.

Because these funds must be used for approved educational purposes, the tax benefit will be muted if your child or grandchild chooses not to go to college. This doesn’t mean the money is lost, though. If you have more than one family member you are trying to help, you could change the beneficiary. You could even apply the money to your own education. Regardless of who makes the withdrawal, though, the tax benefit goes away and the earnings portion of a non-qualified withdrawal is subject to a 10% penalty if the funds are used for unapproved purposes.

Why Would You Want to Use One?

The 529 is a helpful way to contribute to a child or grandchild’s future education expenses, which can be high. The average cost of tuition and fees for the 2017-2018 school year was $9,528 for state residents at public colleges, $21,632 for out-of-state students at public schools and $34,699 at private colleges. College tuition costs are up considerably over the past couple decades. Per the latest data from the BLS, college tuition and fees have risen 47.2% from April 2008 to April 2018.[iii] Since April 2000? Up 153.4%. Since April 1990? 385.4%! Compare that to overall CPI change over the same time periods: 16.9%, 46.3% and 94.0%, respectively.[iv] Moreover, this is just tuition—room and board add up, too. We aren’t saying college tuition is going to keep zooming higher and higher unchecked. But do you want to bank on it falling? Supply and demand strongly argue it won’t.

529 plans can help tackle that total cost of college, but they aren’t the only game in town. There are Coverdell Education Savings Accounts and Uniform Gift to Minors Accounts (UGMA, or UTMA, depending on your state of residence), which have their own advantages and drawbacks. You could also invest in a plain ol’ taxable account, which gives you greater investment options and control (without the tax benefits, of course). Regardless of the option or options you choose, anything you can sock away now and invest will likely help in the future.   



[i] This will vary by state, which determines the full cost of attending an expensive school and/or graduate school.

[ii] This does not include: Booze-soaked Spring Break trips to Cancun or fancy sports cars.

[iii] Source: BLS, as of 5/31/2018. College tuition and fees in U.S. city average, all urban consumers.

[iv] Source: BLS, as of 5/31/2018. All items in U.S. city average, all urban consumers.


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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.