College Planning – 529s

If you are planning on sending your children to college, you have probably heard of 529 plans. Named for Section 529 of the Federal Tax Code, a 529 plan is a college savings account that’s exempt from federal taxes. They have become wildly popular. While they can only be used to fund higher education, there is a higher potential for return. If you are comfortable with the accompanying market risk, 529 plans are a compelling investment option.

One of the big reasons for the popularity of the 529 has to do with tax advantages. The 529 has three major layers of tax advantages.

  1. Tax Deductible – 529 plans are popular because they allow you to invest in education and receive a state tax deduction, as most states participate with a 529 plan and incentive. Each state’s plans are unique. Vanguard has a helpful tool to look up the specific rules for your state. For example, the state of Iowa allows a couple filing jointly to contribute and deduct for state income taxes up to $6,878 in 2020.
  2. Tax-Deferred – Another advantage is that the money grows tax-deferred as it goes up in value leading to college.
  3. Tax-Free – Lastly, the money can be withdrawn tax-free within qualified 529 withdrawal rules. This is a powerful advantage. Most 529’s are either done through Vanguard, American Funds, or financial advisors through an approved custodian. You can’t just set up a 529 with anyone, and again, things vary from state to state. We work with the Iowa Advisor 529 plan and can help you with eligibility, contributions, and fund selection.

A recent major change you should be aware of is that 529 funds can be used up to $10,000 per student for K-12 education per year. Funds used for public, private, or religious schools can also be treated as a qualified education expense with respect to the federal tax benefit. State tax treatment of K–12 withdrawals, however, is determined by the state where the taxpayer files state income tax. You should consult your tax advisor about your personal situation.

Here are a few other reasons people like 529 plans:

  • You can save for anyone who needs an education. This makes it a great instrument for grandparents who want to benefit the grandkids and who have lost many other tax deductions.
  • The person funding the account still controls the account and you can change the beneficiary or child once annually, as it fits your needs.  The money in a 529 does not count against the student when it comes to financial aid. Although we are advocates of no debt, we understand that this ideal may not fit all situations.
  • You spend less time managing investments. Many 529s are using mutual funds that are asset allocation minded or indexed to major indexes, making investing simple and easy.
  • You can access the funds early and will incur just a small penalty. It’s easy to see why these are a popular account type to save up for college, and now even to use for pre-college education.

In the next few articles, we’ll be exploring investment tools for broader purposes than education. Stay tuned!