A Wealth of Knowledge - Spring 2013 - Consider a 529 Plan for College Savings

Many American families find themselves attempting to balance the three largest financial concerns: housing, retirement and education costs.  A 529 plan can help families plan ahead and start savings for a child’s future higher education costs.  A 529 plan is a savings plan for higher education administered by a state or institution.  There are two basic types of 529 plans: a prepaid plan and a savings plan.  As the name suggests, a prepaid plan prepays tuition for a beneficiary at a specific educational institution.  Prepaid plans are not recommended often since they are not typically portable.  A savings plan is a much more flexible option that can be used to attend any qualified institution.


A 529 account can be established for just about anyone: your own children or grandchildren, nieces or nephews, even children of a family friend. Funds added to a 529 plan are considered a gift for tax purposes. In 2013, the annual gift tax exclusion is $14,000 per beneficiary.  Current IRS rules allow front loading up to a maximum of five years of gifting in the first year’s funding of a 529 account.  In 2013, 529 accounts can be funded up to $70,000. You should consult your tax professional when setting up a 529 account as this can create a need to file an informational gift tax return.  Depending on the circumstances, you should also consult with your tax professional to see if you have any generation skipping transfer tax issues.

There is no limit on the number of 529 accounts an individual may establish.  You are limited by how much you can fund for each beneficiary before there is a reportable tax event.  Many plan administrators typically have a limit on cumulative contributions per beneficiary.  Most plans’ limits are generally between $200,000 and $400,000.  When the account balance reaches the administrator’s stated limit, the plan will stop accepting contributions.  The cumulative limit per beneficiary is typically an aggregate of all accounts for that listed beneficiary.


The average annual cost for a four-year undergraduate degree was about $22,000 in school year 2010-11.  The cost of a public institution was about $16,000 vs. almost $33,000 for a private institution.  These costs include tuition, room and board for full time students . Costs have been rising, on average, about 6% annually.

If you were to start saving every month for your child as soon as they were born, you would need to set aside more than $850 per month through their last year of college.  This assumes you pay for four years of higher education at today’s cost of $33,000 annually, education costs continue to inflate at 6% per year, and your 529 savings plan averages an annual return of 7%.

In a different scenario, you and your spouse could open one account and front load a contribution of $70,000 at the beginning of year one.  With the compounding effect of front loading, you and your spouse would only need to contribute less than $290 per month through your child’s last year of college.  This assumes you pay for four years of higher education in the scenario noted above.

If a grandparent is the 529 account owner, the account value does not impact the student’s eligibility for federal financial aid.  Up to 5.6% of a 529 account’s balance is included in the calculation for federal financial aid eligibility for 529 accounts owned by a parent.  Rules for financial aid provided by colleges can vary from the federal calculation.


Gifting to a 529 plan helps to reduce your taxable estate since a 529 plan is excluded from the donor’s gross estate (as long as the listed beneficiary is other than the donor).  An interesting fact is, even though you have completed a gift for tax purposes and it is excluded from your estate, you as the owner of the account still have control of the account’s assets.  This includes the ability to change the beneficiary and management of the assets (within the investment choices provided by the specific 529 plan).  If as the account owner, you front load contributions in year one and subsequently pass away before the front load time period ends, part of the contributions can be added back to your gross estate.


You are not limited to choosing the 529 plan administered by your state of residency, although in some cases this may be beneficial for tax purposes if your home state offers a state tax deduction for contributions.  Many states have 529 plans that are available to non-state residents. There is no federal tax deduction or credit for contributions to a 529 plan.

Plans typically have a prepopulated list of mutual funds from which you can select (similar in this respect to most 401(k) retirement accounts). You should consider a 529 plan that offers index-based mutual funds. These funds will usually have the lowest expense ratios. In addition to the funds’ expense ratios it is important to look for plans with low administrative fees for your account.  Lower administrative fees and expense ratios will maximize the performance of the account and the amount of savings available for the beneficiary.


Assets held in a 529 account grow tax deferred.  Distributions are tax-free if used for qualified education expenses as defined by the IRS. Qualified education expenses for the 529 beneficiary includes higher education’s tuition, required fees, books and supplies.  Room and board may also be qualified expenses for the beneficiary attending a qualified institution if he or she is at least a half-time student.  If a distribution is not used for a qualified expense, there is a 10% penalty in addition to ordinary income tax due on the earnings portion of the distribution.


Most plan administrators give account holders the choice among self-managing their account’s investments using a pre-chosen list of funds or using automatic investment options. The automatic investment options could be ideal if you have limited investment experience or prefer to spend the least amount of time managing the account. These are usually asset allocation models based on risk tolerance and the beneficiaries’ age. During younger years, the account will be invested more aggressively.  Over time as the beneficiary nears college age, the account will automatically change to a more conservative allocation.

A 529 plan gives individuals a great way to save for higher education expenses.  With college costs rising on average at a faster rate than normal inflation, the tax-free compounded growth of a 529 account is critical to maximizing savings for the beneficiary. When choosing a 529 plan, pay attention to the plan’s stated administrative fees and underlying funds’ expense ratios. A plan employing index funds can offer lower expense ratios, potentially increasing the future savings for the beneficiary.  If considering a 529 plan, you should consult with your tax advisor or financial planner to make sure any potential gift tax issues or generation skipping transfer tax issues are thoroughly reviewed before the account is funded.



A Wealth of Knowledge - Spring 2013 Issue

Aaron Kaiser is an Audit Partner and member of the Professional Practice Group and a leader in the Real Estate accounting services group.

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