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  • Writer's pictureJeran Van Alfen, CFP®

3 Things You Need to Know About Your 529 College Savings Plan

It is finally sinking in…I have exactly one year until my oldest child is enrolled in college! As I try to push down the emotions that come with counting down the months, I am also trying to prepare for the upcoming tuition bill that we will be facing. I have helped numerous clients plan for paying for college, so as I review my own financial plan, I am reflecting on all of the questions that I have dealt with over the years. I thought I would share 3 of the most common questions that I receive concerning the 529 college savings plan.

First, why use a 529 college savings account?

The 529 is a tax-advantaged account that is designed specifically to pay for higher education expenses. The main advantage of the 529 is the tax treatment of your gains and earnings. In a 529 plan, the money grows tax-deferred, similar to your retirement accounts (401(k), IRA, Roth IRA, etc.). This means that you won’t pay taxes each year on the interest, dividends and capital gains that are received in the account during the year. Tax-deferred savings can have a large impact on the amount saved over time. Consider the chart below. These figures are purely hypothetical, but it shows the possible impact of tax-deferral over 18 years. This assumes a $1,000 investment and $300 per month with a federal tax rate of 35%.

A taxable account such as a brokerage account, savings account, or mutual fund could be a good way to save for general expenses that you may want to help your child with. However, when it comes to college expenses specifically, then a 529 plan can provide valuable tax savings if you start saving for college early.

Here are few other tax-related considerations:

  • Some states offer a state-tax deduction for contributions to their state-sponsored 529 plan. For example, Utah currently offers a state tax credit of 4.65% for contributions up to $4,580 to the state plan for couples married filing jointly. In comparison, California does not currently offer a state tax deduction nor a credit for contributions to the state plan.

  • In general, qualified withdrawals from a 529 plan are Federal and State tax free. Some states have tax penalties for non-qualified withdrawals (In general, you should plan on using your 529 money specifically for qualified college expenses to take advantage of tax benefits).

  • You can use 529 money to pay for up to $10k per tax year of K-12 tuition and up to $10k total of student loans. (However, CA imposes state taxes and a 2.5% penalty tax for withdrawals to pay for primary or secondary education/K-12).

Second, how is money invested in a 529 college savings account?

Your investment options in your 529 account will depend on the 529 plan provider that you use. Most platforms offer a variety of mutual funds to choose from to invest your money. The funds offered typically cover the major asset categories including US stocks, international stocks, bonds, and money markets. You can construct your own diversified portfolio with the funds that are offered.

In addition, most platforms also offer model portfolios that you can choose from. Model portfolios provide an automatic allocation among the funds based on your preference for risk/return.

The other common (and typically most convenient) option is a target enrollment portfolio. The portfolios are designed with the beneficiaries’ age in mind. The money is allocated for more growth (more exposure to stock funds) when the student is young and then automatically shifts toward preservation and stability (more exposure to bond/cash funds) as the student approaches the enrollment year.

Using a diversified portfolio is extremely important if you have time for your money to grow. The hypothetical below shows the difference of investing $200 per month over 18 years in a low interest savings account vs an investment earning 6%:

Third, how do you withdraw money from a 529?

It is extremely important to plan ahead for how you will access your 529 money. To do this, you need to know what the published costs are for attending the institution that your student is attending. These costs can be found on the institution’s website. In addition to the published costs, there are a few other items that count for qualified expenses. This is a great article from Fidelity that explains how to plan and withdraw money from your 529:

If you need assistance planning for college expenses or navigating the college funding process, please reach out and we are happy to help! I can now officially say that we are in this together!

Click here to schedule a planning consultation!

Centered Financial, LLC is a registered investment adviser offering advisory services in the State of California, Utah, Texas and in other jurisdictions where exempted. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques, strategies, or investments discussed are suitable for all investors or will yield positive outcomes. To determine which strategies or investment(s) may be appropriate for you, consult your financial adviser prior to investing. Any discussion of strategies related to tax or legal planning is general and is not intended as tax or legal advice. Please consult appropriate tax and legal professionals for recommendations pertaining to your specific situation.

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