It might take a village to raise children, but it takesseveral potsof money to put themthrough college and one of those pots isn’t looking so shiny as before.
The latest report on college funding from Sallie Mae, theeducation-financing company,shows parents and students are relying less onincome/savingsand turning more to scholarships/grants.Borrowing, the third major pot, has stayed about thesame.
This savings slowdownisn’t too surprising given that Americans also are having trouble saving forretirement and other goals. But it’s a bit baffling inthat a major type of savings account,known asSection-529 plans,continues to improve, with somewhat better tax breaksand investment options.
“They’re an easy, tax-efficientway to save for the second or third most important financial goal that most people have,” said Rich Polimeni, director of aneducation savings program at Bank of America Merrill Lynch.
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Nevertheless, use of 529 plans has”plateaued,” said Sallie Maein its latest How America Pays for College report,preparedlast year. Some 17% of families usedthe accounts named after a section of the Internal Revenue Code to foot some college costs during the 2012-2013 academic year, decliningto 13% last year.
Assets in 529 plans stillare growing, helped by stock-market gains, but contribution activity hasleveled off,reports theCollege Savings Plan Network, which counted $275 billion in 529 assets as of2016.
Many families just don’t have money to spare, but misconceptions and misunderstanding might explain part of the slowdown.
Here are eight things you might not realize about 529 plans:
1. You don’t need to meet any income guidelines: Unlike Individual Retirement Accounts, you can open a 529 account even if you’re a millionaire, as noincome caps apply.There’s no curtailment of the tax benefits, either. The main one is that investment earnings potentially grow free of federal taxes.
You can’tdeductcontributionsto a 529 plan on your federal taxreturn, but more than 30 states allow full or partial deductions, according to savingforcollege.com.Most programs feature low investment minimums, often as little as $25.
If you use the money to meet college costs or even those for technical or vocational schools proceeds can be withdrawntax-free. If instead, you pull outmoney for non-education purposes, you would owe taxes on any earnings and a 10% tax penalty. Thus, College-focused 529 accounts somewhat resemble Roth IRAs, where there’s no federal deductionbut where withdrawals usuallycome out tax-free.
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2. You don’t need to use the accounts for college.You read that right: These are college savings plans, but there’s no requirement to use the money for college. Nevertheless, it’sbest to use proceeds for higher education, as distributions would then come out tax- and penalty-free. Permissibleexpenses, beyond justtuition, include housing, books, computers and much more.As noted, you also can use the money to finance training intechnical or vocational schools. And thanks tolast year’stax-reform legislation, proceeds can be taken out, tax-free, and used to pay for up to $10,000 annually intuition forKindergarten through 12th grade.
3. You don’t need to give the money to the intended recipient. Suppose your kid decides not to attend college. You can transfer the accountbalanceto another beneficiary, such as a younger sibling. You also could transfer itto someone unrelated to your child or use it for your own higher-education expenses, should you returnto school.
“The donor or owner keeps control for the life of the account,” said Polimeni, who chaired a recent conference in Phoenix of theCollege Savings Foundation.”There’s tremendous control and flexibility.”
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4. You don’t need to give it away. It’s even possible for an investortopullout proceeds for personal use. Owners”can withdraw funds at any time for any reason,” noted savingforcollege.com. This can be handy if the donor runs into serious personal financial problems or if the intended child doesn’t attend college or wins a full-ride scholarship. However, donors who transfer 529 assets fortheir own non-college useswould face taxes on earnings and that 10%penalty.
5. You don’t need to be a parent to use these accounts. Grandparents also can set up and fund 529 accounts, as canuncles, aunts, other family members andeven friends.”You don’t even need to be related to the student,” said Polimeni. The person who sets up the account retains considerablecontrol over it, including the decisionon whomto name as beneficiary and where to invest.
Given the lowminimum contributions,nearly anyone can helpsave for someone else’s higher education.
6. You can use another state’s plan. The accounts are named after a section of the Internal Revenue Code and feature earnings that are tax-free on federal returns. Yet the programs are run by the various states in partnership with investment companies.
Investors may contribute to their own state’s plan or utilize a program sponsored by another state. “We suggest looking atyour own state’s plan first,” said Polimeni. Some states allow a deduction for residents who utilize these plans, but other states either don’t offer such incentives or don’t require residents to use them in-state. Proceedsthen can be used to pay for college anywhere in the country.
(In a different and smaller type of 529 program, the “prepaid plans,” investors purchase tuition for use at specific colleges.)
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7. You don’t need to fret over investment decisions. Nearly all 529 plans utilize mutual funds and exchange-traded funds or ETFs. This makes sense, as these vehicles are broadly diversified and typically managed atlow cost.
Fundswith stock-market exposure usually arethe way to go, especially for young kidswhose accounts might growfor 15 or 20 years. Many age-linked fundsstartout aggressive when a child is young (with high stock-market exposure), then growmore conservative over time.
Incidentally, the accounts don’t need to be liquidated as soon as the beneficiary turns 18.Funds may be applied for graduate school, for example.
8. You might notdisqualify your child from financial aid.For yourchildren to receivefinancial aid, it’s best not to have a lot of assets held in their names. When parents set up 529 plans, the assets are counted less heavily for financial-aid eligibilitythan if the same assets were held by the child in, say, a custodial account.
Supposea529 account held by the parents isworth $100,000 by the time a child applies for college. In this case, around 5.6% of assets, roughly$5,600, would be counted againstaid eligibility, said Polimeni. But if the same $100,000 was held in a non-529custodial account, 20% or $20,000 would get counted.
Savingforcollege.com offers a handy calculator for runningfinancial-aid scenarios.
Reach Wiles at email@example.com or 602-444-8616.
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