The following article was written by Bob Hartzell who is a freelance writer for Get Degrees®. They feature 100′s of majors from accredited online colleges and universities in various fields.
Eight reasons why the 529 is the best college savings plan
The 529 college savings plan is probably the most flexible college savings option out there at the moment. It is named for Section 529 of the Internal Revenue Code, which created the fund concept and codified it in 1996. 529 Savings Plans function much like a 401k or an IRA – they are accounts into which you place funds that are then put into mutual funds or other mainstream investments.
Section 529 plans are administered by state agencies, but the investing, record keeping and reporting is usually delegated to a commercial investment firm. Every state has at least one 529 in place and some have several.
1. Impact on Scholarship and Financial Aid Eligibility is Minimal
When a college financial aid office is calculating student eligibility for aid, they will only apply 5.64% of the 529 Fund value as an asset. If the student controls the fund, that same 5.64% is used to calculate the Expected Family Contribution (EFC) which is based on assets and income. For a standard student savings account, the financial aid calculation applies 20% of the balance. This protective feature is one of the major innovations of a 529 plan.
2. Tax Free when Withdrawn to Pay for College Expenses
Unlike IRAs and other federal savings plans, these college funds are not subject to taxation upon withdrawal. They are a great mechanism for building a college nest egg that is subject to substantial tax benefits and that does not alter financial aid eligibility. Here are several ways that everyone in the family can contribute to building tax-free college funds.
3. Tax Breaks on Savings Contributions
While your contributions to a 529 are taxed by the IRS, thirty one states and the District of Columbia offer breaks in state income taxes for 529 contributions. There are generally no limitations to your selection of a 529 plan – you can live in California, invest in an Indiana 529 and send your student to a Florida university.
4. Students can Contribute Too
If your student is working to help save college dollars, they can contribute to the 529 fund and not have their eligibility for financial aid come under scrutiny. High school students working part time aren’t generally going to be paying federal income taxes, so those dollars are tax free going into the account and coming out.
5. Fund Growth is Tax Free
The investment profits accrued by a 529 are also tax free if applied to legitimate college expenses. It’s another form of shelter for college savings that are set aside to grow as an investment while the student grows to college age. Legitimate college expenses include books, tuition and room & board.
6. Family Members can Contribute Subject to Gift Tax
If a grandparent or other family member wishes to contribute to the 529 they can do so as a gift and do so tax free if the gift is under the $13,000 annual federal tax-free limit. Those donations are also limited by the other strings included in gift tax rules, so the law is worth checking.
But unless the contribution is a large one, it’s a great way to help bring a grandchild or favorite niece along with minimal tax impact on anyone. If a grandparent owns the 529 Fund, it is not calculated in financial aid eligibility at all.
7. Fund Management is Simple
It’s important that all withdrawals apply to eligible college costs. Ineligible expenditures are subject to taxation plus a 10% penalty. But dispensing the funds is relatively simple – it can be done by the plan manager to the plan owner (parent, grandparent or student), to the student or to the college. At the end of the year the college will inform you of the eligible expenses charged to the student beneficiary.
8. Reward Programs that Link to 529 Plans
The “rewards” craze that started with airline miles and has overtaken the credit card industry can now be applied to certain 529 plans. Over time, your purchases can generate rebates that add up to hundreds, and potentially thousands, of extra dollars for the college fund. For example, The Fidelity 529 Rewards American Express Card offers a 1.5 percent rebate on your card purchases for direct deposit to any one of the five Fidelity-managed 529 plans.
What other features do you love about the 529 plan?
{ 7 comments… read them below or add one }
Great advice!
We’ve got an article up about 529 plans as well: http://www.lifetuner.org/topics/18-kids-family/articles/65-saving_for_college_529_plans
Vanguard has a good comparison of college savings options. https://personal.vanguard.com/us/insights/collegesavings/college-savings-options
Fidelity. 2%. No?
http://personal.fidelity.com/products/checking/content/amex_rewards_card.shtml.cvsr?showcard=college
One point to add, a gift to a 529 can be advanced up to 5 years, so I can gift my daughter $65,000 each from me and $65,000 from my wife and still not tap into any gift tax issues.
Please! Are you serious! I guess they are good if you want to pay full price for college. If you have $50,000 in a 529 and your student is going to college that costs $30,000/ year with 3 kids. The income of the family is $80,000 per year. Do you think that they are going get financial aid? NO!!! None. The college is not going to give them a dime. Could they get money later on? Maybe, it depends on the college. If the college is a base year school, NO! This means that what they get the 1st year is what they get for all four. The student is already in the college and through the doors, the college does not need to invest in the student anymore.
529′s are good for some families but not for all. Especially if they are a financial aid candidate! These 529′s are going to impact the merit aid that the student may receive. It’s great that parents save for college and by all means do so, there are just other vehicles that will be off the college radar that you can still use for college. I think that 529′s are great for affluent families but not for the middle or lower income.
Don’t forget to warn your readers about the affluent families’ limitations on the deductibility of their 529 “qualified” expenses withdrawals. The 529 withdrawals’ deductibility are limited for these purposes. You may also want to seek counsel from those who have lost a large portion of their 529 values due to the stock market declines. Learn from their mistakes. Funds allocated for college should be “nonassessible”, guarantee no loss of principal, and not be invested in the market.
To Manny,
At that income level most of your financial aid is going to be low interest federal loans and maybe work study. Don’t expect much need based gift aid unless you are fairly destitute.
To Minda (and Manny),
A family of five with $80,000 income would qualify for Cal Grant awards of $3,400 to $9,700 need-based gift aid every year!