Like most industries, financial planning has its fair share of jargon and acronyms. These are commonplace for those of us working in the industry but can be like a foreign language to clients. I thought I would use a Friday letter every couple of months to explain the more common abbreviations in our world. 

This month is the abbreviation 529 Plans, which are “qualified tuition plans” for education expenses authorized by Section 529 of the Internal Revenue Code. If you have children, you may be familiar with the term but may not know exactly how to use these accounts. So, what exactly is a 529, and how does it help with education expenses? A 529 plan is a savings plan with tax-free growth if used for qualified education expenses. The tax benefits can be powerful in helping save for college, but there are potential drawbacks with these plans. 

What are the key benefits of 529 account? 

• Earnings are tax free when used for qualified education expenses.
• Potential state income tax deduction for contributions (varies by state – in Arkansas, a married couple can deduct $10,000 per year from their state tax return)
• Account owners retain control of the account versus a custodial account (UTMA/UGMA) where child gets control at a certain age.
• Easy way for grandparents and others to contribute towards college savings.
• Increased flexibility added in the past few years such as the ability to use for K-12 tuition ($10,000 per year), student loan repayment ($10,000 lifetime limit) and rollover to a Roth IRA (after 15 years up to $35,000 lifetime limit subject to annual IRA limits)

What expenses are considered qualified education expenses?

• Full tuition for undergraduate and graduate school
• Fees
• Room and board
• Books and equipment for undergraduate and graduate school
• K-12 tuition up to $10,000 per year
• Student loan repayment of up to $10,000 lifetime
• Registered apprenticeship program fees

When does a 529 plan make sense?

If college savings for children or grandchildren is a goal, the tax benefits of 529 plans make them very attractive. If you live in a state with an additional state tax deduction, the benefits are even greater. With the tax-free growth, we recommend starting savings to these accounts as early as possible to maximize that growth. Even if you start modestly, funds that are deposited before kindergarten starts will have over a decade of tax-free growth before college. Having an account set-up for your child will also provide a way for relatives to contribute gifts if they want to help with college funding.

Lack of flexibility is the biggest downside of 529 plans. If the funds are not used for one of the qualified reasons above, the earnings will be subject to tax plus a 10% penalty. For that reason, we do not recommend more than 50% of college savings be inside a 529 plan. Having your savings in an account with greater flexibility reduces the risk of incurring a penalty if college plans change down the road. However, the changes made recently (especially the rollover to Roth provision) have made these accounts more attractive with lower risk for overfunding than they had in the past.

We’d love to hear from you. Let us know if you want more information on 529 plans or if there are any jargon/abbreviations you would like covered in a future email. As always, we are here for you. Please email or call if you want to set up a Zoom videoconference meeting or talk by phone.

Mary McCraw, CFP®

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