529 plans: The best way to pay for college

By Steve Doster

With the cost of attendance to four-year universities constantly increasing, it’s no wonder that parents are seeking ways to help out and save their children from incurring massive amounts of debt. If you’re a parent of a young child, one of the best ways to save for college is by opening a 529 plan.

The benefit of a 529 plan is that the investment earnings are totally tax-free when the money is used for education expenses. And education expenses include much more than only a four-year university. Trade schools, community colleges, and graduate schools are all acceptable places to use this money. And as of January 2018, 529 plans can be used for K-12 private school tuition up to $10,000 per year.

A 529 plan is an investment account for future education expenses. Each state offers their own 529 plan. 529 plan contributions aren’t deductible at the federal level, but over 30 states offer a tax deduction or credit for contributions. If you live in a state that offers a deduction or credit, you should open the 529 plan in your state.

Unfortunately, California does not offer a state tax deduction or credit so you can shop around the country to find the best plan. Check out www.savingforcollege.com for help with the process of selecting the right plan for you. This is a great resource that compares costs, investment options, and service levels.

After you have selected and opened your 529 plan, you contribute after-tax money into the account, choose mutual funds to invest the money, and let it grow. When the time comes, money is withdrawn from the 529 plan without owing any tax on the investment growth. The caveat is that the money must be used for education expenses.

Contributions to a 529 plan are considered gifts to the beneficiary. The IRS allows for an annual gift up to $15,000 for 2019 (this increases each year) without filing a gift tax return. Each parent can contribute up to $15,000 into each child’s 529 plan without exceeding the gift limit. You can also pre-fund a plan with up to five years’ worth of contributions in one lump sum. So, using the 2019 numbers, parents could fund up to $75,000 per person ($150,000 per couple) into one child’s 529 plan as a one-time lump sum, and then not contribute for five years.

A concern of many parents is, “What if my kid doesn’t go to college?” Know that if your child doesn’t use all the 529 plan (or any of it), it can still be used for another relative or even for yourself. This can be done very easily, just by changing the beneficiary on the account. So, by opening a 529 plan, you actually have the potential to help many family members, not just one child.

If withdrawals are not used for qualified education expenses, then income taxes and a 10% penalty will be applied to the investment earnings portion of the withdrawal. If you aren’t sure what counts as a qualified education expense, check with your 529 plan to confirm.

This may seem nerve-wracking, but don’t worry! As long as your 529 plan is used for the purpose of your child’s education, you will be just fine. And know that if one kid doesn’t need it all, the leftover funds can still be applied to another child or relative.

Helping pay for your child’s education is an expensive financial goal! Do your best to eliminate some of the stress of those high costs for both you and your child by opening a 529 plan.

— Steve Doster, CFP is the financial planning manager at Rowling & Associates – a fee-only wealth management and CPA firm helping individuals create a worry-free financial life. Rowling & Associates works to a fiduciary standard of care helping people with their taxes, investments, and financial planning. Read more articles at www.rowling.com/blog.