529 Myths Prevent Understanding of This College Savings Tool
By Joe Messinger, CFP®
April 5, 2019
In America today, only 56% of families with children are saving for college and only 30% of those who are saving are using a 529 plan to do it! We are shocked by this figure! Certain 529 myths still exist which prevent families from understanding the value of this important college savings tool.
The number of families taking advantage of 529 plans is rising, but many people still don’t quite understand how these plans work (or even what a 529 plan is–only 29% knew what a 529 plan was in 2018.)
What myths are we talking about?
Myth 1: I can only open the 529 savings plan offered by my state.
You are not limited to the 529 plan offered in your state. You can use any plan in any state. If you plan on taking advantage of any state tax credit for 529 contributions, you may have to use a plan in your state to qualify. However, you aren’t limited to only one plan. You can open one plan in your state and fund it up to the maximum amount for the tax credit ($4,000 in Ohio per year per beneficiary). In addition, you can open a separate account in another state which might offer more desirable investment choices or lower fees.
Myth 2: I can only use 529 savings in colleges within my state.
529 savings plans can be used at any post secondary educational institution eligible to participate in a student aid program run by the U.S. Department of Education. The list of eligible institutions even some international institutions can be found here.
Myth 3: Only parents can open 529 plans for their children.
The truth is anyone can open a 529 plan for any beneficiary, including a family member, a friend, or even yourself.
Myth 4: I can only contribute up to the “state’s limit” into the 529.
As we mentioned above, many states offer tax credit for 529 contributions. In Ohio, the maximum tax credit per year per beneficiary is $4,000. But don’t confuse that limit with the amount you can invest in the plan. The IRS does not specifically limit the amount of money you can invest in a 529 plan. However, there are some limitations.
The various state plans will have maximum amounts that can be invested. High limit states include California at $529,000 and New York at $520,000. Very few families have the resources to reach those limits.
Pay attention to gift tax limitations though. In 2019, the gift-tax exclusion kicks in at $15,000 for each individual. A married couple could contribute $30,000 total per beneficiary. Have multiple children or grandchildren? This gift tax limit applies separately to each child. Something to keep in mind for grandparents looking to lower estate taxes. If they have two grandchildren, they can gift away up to $60,000 per year. (Read more about things grandparents should keep in mind, including how to front load this funding.)
Myth 5: I will lose my money if my child doesn’t go to college or they get a scholarship.
First, if your student, the beneficiary on the 529 plan, decides not to go to college or gets a great scholarship which will pay for much of it, you can change the beneficiary to another family member like another child, niece or nephew, or even yourself or your spouse. Some families are also now thinking of leftover 529 funds as a legacy plan for their unborn grandchildren. Imagine 20 to 30 years of tax deferred growth in the market and using the funds for your grandchild’s education.
Second, 529 funds can be also be used for other post secondary educational plans like trade schools or even cooking school. If your child received a scholarship for their undergraduate education, the 529 can be used for graduate school as well.
As a last resort, you can take the money from the account as a non-qualified distribution. You will pay taxes on the earnings made in the account, not on the amount of money you invested. You will pay a 10% penalty on those earnings as well.
Myth 6: Financial aid awards will be impacted by money saved in a 529.
We call this a “sort of but…”. When completing the FAFSA in order to determine need-based aid, they will ask about the total money parents have saved in 529 plans (for all children, not just the one they are applying for).
A portion of a parent’s assets are protected by the Asset Protection Allowance (APA). The amount of the APA is based on the older parent’s age and the number of parents. A two parent family where the older parent is 48 would have an APA of $21,300.
The assets in excess of the APA limit are included in the Expected Family Contribution calculation at a rate of 2.4% to a maximum of 5.64%. For example, if a family has 529 savings of $10,000 in excess of their APA, then $564 will be added to their expected contribution. However, the savings realized by investing in a 529 plan will most likely exceed this small amount of $564.
Myth 7: 529 savings can only be used for tuition.
Actually, 529 funds can be used to pay for any “qualified educational expenses” including tuition, room and board, necessary fees, textbooks, and even computer equipment or internet expenses or graduate school.
Why are 529 plans such a valuable savings tool?
529 plans have important tax benefits. Contributions grow tax free and withdrawals for qualified higher education expenses are tax free. How often does that happen? Tax free earnings! Plus, you may receive a credit on your state tax filing.
The plans are very flexible and give investors choices for their investments including age-based plans that are professionally managed for the appropriate risk level. Shop around and find the one (or more) plan(s) that are just right for you. Don’t let the 529 myths stand in your way.