As the cost of college has grown dramatically over the last couple of decades, fewer families are able to fund it from cash flow. As a result, increased importance is placed on planning for educational expenses.
One tool utilized for educational planning is the 529 plan. This plan is named after Section 529 of the Internal Revenue Code created by Congress in 1996 – an important Code that in short, offers families a simple, tax-efficient way to save for higher education. As a result of going through an education planning review, many CCM clients have opened 529 accounts for their children and/or grandchildren. Assuming distributions are used for qualifying educational expenses, 529 plans allow one to save for educational expenses in a vehicle that is tax-free of all portfolio investment growth and earnings.
Many of our clients also appreciate the gifting aspects of a 529 plan as it allows parents and grandparents to gift the value of education to children and grandchildren while potentially reducing their own income or estate tax exposure. A married couple can annually gift a total of $28k to any individual, free of gift tax implications, and up to $140k into a 529 plan for each individual, free of gift tax liability. This allows a couple to remove the assets from their estate, provide tax-free growth on those assets, and bestow the value of education to future generations. Additionally, a special tax provision and election applicable to 529 plans allows either an individual or a couple to accelerate up to five years of their annual gift tax exclusion at one time into a 529 plan. Thus, for a couple, a total of $140k may be placed in one year into a plan. For a single person, the accelerated amount is $70k. This acceleration of funding in the early years of a child’s life allows for compounded tax-free earnings and growth over more years.
As we’ve assisted families in identifying the best option for their situation, we have developed a short list of considerations. Facets of a 529 plan we look at when comparing options include:
- State tax benefits– each state has varying tax advantages. You do not need to utilize the plan of your home state, although in some cases there are tax advantages for doing so. A great online tool that we have used to compare plans is located here: savingforcollege.com/compare_529_plans
- Costs and fees – paying less in fees equates to better investment results, so like with anything else, costs truly matter.
- Investment options – broadly diversified options and age-based allocations allow for mitigating portfolio risk.
In general, given the rising cost of education, 529 plans make sense for many families. They are a solution we commonly recommend as a result of education planning with clients. If you have any questions about starting a 529 plan or education planning in general, please connect with any of us on the CCM advisory team.