529 College Savings – A Great Vehicle, Only A Few Potholes
COLLEGE COSTS – Continued escalating costs, funding costs, student debt – ALL TO HIGH: What to do, oh my!!
Rising college costs and the horror stories of current student debt severely impacting current millennials has most young parents, and likely their grandparents who hope to perhaps help their grandchildren with education costs, alarmed – and not just a little. So let’s take a look at an option that offers some relief for those who either start early enough or those who are fortunate enough to contribute more significantly later – this might be grandparents. As the auto magazines review vehicles, let’s take a look at the base vehicle and then explore the options and add-ons before critiquing or suggesting where to be careful.
The appeal of Qualified Tuition Plans, often referred to as College Savings Plans or frequently called 529 Plans in reference to the applicable Tax Code Section, is that investment earnings and returns aren’t taxed as long as the money’s used for postsecondary education. Qualifying expenditures include tuition, books, computer and other equipment, and even room and board, with some limitations. States set the investment options, and often add on additional tax incentives. Despite these perks, less than 3 percent of American families use the plans. More families should be taking advantage of these plans. The rules are incredibly flexible about transfers within your family group (i.e. amounts may be transferred to siblings and a variety of other family members) for any amounts that are left unused, and the very worst that can happen is that ultimately the earnings get taxed to the recipient if they are not used for education costs, with the result that at a minimum there is a tax deferral on the earnings. So, to summarize, as a parent, grandparent, aunt, uncle, friend, etc., you can transfer funds into an account for a designated person’s educational expenses that will grow tax free and withdrawals will be tax free so long as the money is used for postsecondary education. So why are you not using one for your children, grandchildren, etc.?
If you start young enough – say when your child is two – and deposit $ 3,000 per year until the child is 18 and ready for college and generate earnings of a modest 4% per year you will have accumulated roughly $ 75,000 for the child’s education. With current costs at our two largest universities in South Carolina, that balance would cover about three years of cost of attendance. The question is pervasive; why are you not using a 529 College Savings Plan for your child or grandchild?
Additional benefits and “potholes” to avoid
There is no federal deduction for contributions to 529 Plans, since only the earnings are taxed, but South Carolina does allow for a deduction for amounts contributed to the South Carolina plan and it is a very good plan when compared nationally. An additional feature for the South Carolina plan is that amounts contributed before April 15th can be deducted on the prior year’s return. Further, the deductible amount is unlimited; so the contributor could utilize the multiyear exclusion afforded education gifts and contribute $ 70,000 per recipient and deduct the full amount on the South Carolina return. In addition, if there is an established plan, contributions for current tuition can be made to the plan and immediately disbursed, and, thereby, creating a current South Carolina deduction for tuition paid.
Now we turn to the critique; hopefully, as demonstrated above 529 plans offer multiple benefits but there are some potential issues that should be noted.
- Payments made from a 529 Plan do not qualify for the available federal education tax credits (American Opportunity Credit or Lifetime Learning Credit).
- Withdrawals from accounts owned by grandparents are counted against the grandchild student in the following year’s financial aid calculations. There are some “workarounds”, but still something that account owners should be aware of.
- Withdrawals and expenses need to match; account owners or those making withdrawals need to make sure that the expenses are paid in the same year withdrawals are made.
In today’s world, more than ever, education is critical; start planning now for that child or grandchild!