Are you making best use of the 529 College Savings Plan, or have you been procrastinating when it comes to putting your best-laid plans in place? Let’s step through the key considerations involved, so you can move from pondering to progressing toward your kids’, grandkids’ or even your own college funding.
Back to the Basics of the 529
Happy belated birthday to the 529 plan! Named after Section 529 of the Internal Revenue Code, this tax-favored savings tool for college-bound Americans turned 21 years old itself last month, in August 2017. While hardly exhaustive (and as subject to change as any other tax laws), here’s a look at some of the 529 plan’s current characteristics:
- Ownership – Each plan has an owner who retains control of the assets – usually a parent or grandparent.
- Beneficiaries – Each plan has a beneficiary. This is usually a child or grandchild, but you also can name yourself if you want to pursue additional higher education for fun or profit. The plan owner can usually change the named beneficiary if circumstances change.
- Investment selection – Each plan offers a distinct “menu” of investment options. No substitutions. If it’s not on the menu, you can’t invest in it within that plan.
- Federal taxes – After-tax contributions grow tax-free, similar to the way a Roth IRA works.
- State taxes – While you don’t have to invest in your own state’s plan(s), some states (including Illinois) offer state tax breaks if you do.
- Fund withdrawal – 529 earnings can be withdrawn federal-tax-free for qualified college expenses. If you withdraw earnings for non-qualified expenses, they will be subject to income tax, plus a 10 percent penalty.
- Financial aid – 529 plan assets are treated as a parental asset (even if the plan is owned by the child). So they can affect financial aid eligibility, but not as significantly as if they were considered a young student’s personal asset.
- Possibility of using 529s for K-12? - The 2017 federal tax overhaul expanded tax free withdrawals from 529 plans to include K-12 tuition. As always, check with your financial advisor and tax advisor to ensure your are complying with both state and federal tax laws when taking distributions to ensure you’re complying with all the rules.
A Three-Step Recovery Program for 529 Plan Procrastination
With all 50 states plus the District of Columbia offering at least one college savings program to consider, it’s easy to get gridlocked, and decide not to decide. Here are three handy questions to narrow down the field and find the right-fitting 529 plan(s) for your family’s college savings.
- What’s inside the box? Does a plan’s investment selections complement or conflict with the principles of sound, evidence-based investing? Will the plan help you pursue expected market returns while minimizing unnecessary risks within your college savings efforts as well as within your overall investment portfolio?
- What will it cost you in operating expenses? Typically, 529 plans structured according to the tenets of evidence-based investing are inherently cost-effective solutions. But be sure to double check. Obviously, the higher the costs, the more they’ll eat into your end returns.
- What will it save you in taxes? It makes sense to balance a plan’s costs against its tax benefits, and then compare the apples-to-apples results with other offerings. If your state offers generous benefits for participating in its 529 plans, it may be worth staying in-state.
Inside Illinois 529 Plans
Since The Cogent Advisor is headquartered in Illinois, I would like to take a moment to zoom in on its 529 plan offerings. This year, we saw some important changes made to our Bright Start 529 Plan, including reduced fees, additional funds, and a new custodian to hold the plan’s assets.
While you should always do your due diligence to ensure the particulars make sense for you, we are appreciative of Bright Start’s Age-Based Index Investment Options in the direct-sold Illinois 529 Plan. (Direct-sold means you can access it on your own, with or without an advisor’s assistance, and without any extra expenses being kicked back to an advisor.)
With all-in fees between 0.12%–0.15% (as of June 19, 2017), Bright Start’s Age-Based Index Investment Options seem reasonably priced and use Vanguard index funds that shift from aggressive to more conservative asset allocations as the beneficiary ages. Illinois also offers a Multi-Firm Investment Options line-up, which includes Dimensional Fund Advisor funds. But, because it includes other solutions that engage in “active” stock-picking and market-timing pursuits, we typically stick with the indexed portfolios when comparing Illinois 529 plans with other possibilities.
Parting Wisdom for Every Parent, Nationwide 529 Plans
Before we move on, I want to wrap with a delicate, but important issue to factor into your college planning. That is, your own retirement funding really should come first. To quote BAM ALLIANCE’s Director of Personal Finance Tim Maurer, “Parents: Don't Sacrifice Yourselves on the Altar of Your Child's Higher Education.” Here’s Tim’s article, which we shared earlier this year. It’s well worth revisiting at this time.
Now, go forth and save for college.