Managing A 529 Plan Based On College Expectations

By Mark P. Cussen, CFP®, CMFC, AFC | August 28, 2014 AAA
Managing A 529 Plan Based On College Expectations

For families who are saving for their kids’ college educations, 529 plans have become one of the most popular vehicles in America . These plans offer unique tax advantages and also allow the account owner to retain control of the funds after the beneficiary reaches college age. Of course, the money in these accounts is also counted as an asset of the plan owner, so parents who fund these plans will have to list them on their child's FAFSA form. College isn't the only thing parents and other donors, such as grandparents, need to save for during this period; they also have to start thinking of retirement and the other needs of their family. Use these strategies to make sure the money you save is shaped to the needs of the children who will use the funds.

Prepaid vs. Savings Plans

One of the first issues that families need to consider when opening a 529 account is whether the student beneficiary will attend a school in their current state of residence or enroll somewhere else. Of course it is not always possible to predict this, but this decision can determine which type of plan to use. While prepaid plans allow donors to pay for future tuition with today’s dollars, they can only be used for qualified in-state institutions, whereas savings plans can be used for any school regardless of location. The decision about what range of schools the student will be able to choose among is critical.

Equal vs. Equitable Contributions

Parents who are saving for more than one child may be initially inclined to make equal contributions to each 529 account in the interest of fairness. While there is nothing wrong with this idea per se, from a time-value-of-money perspective this may not be the best strategy. Older children have less time for their money to grow before they will need to begin withdrawing it, while small children have a longer time horizon over which their savings can compound.

Parents or donors who want each child to graduate from high school with roughly an equal amount of money available, factoring in inflation, may therefore want to weight their collective contributions towards the older siblings.  A financial advisor or customer service agent for the plan can help families mathematically determine the best way to do this.Remember that unused funds in any child's account can be transferred to another beneficiary.

The Scholarship Factor

Another key issue parents face when it comes to funding 529 accounts is the likelihood that one or more of their children will receive a scholarship. Students awarded this type of financial aid may not need nearly as much assistance as those who must pay their own way. Of course, this can be a gamble for families because of the different types of scholarships that are available. Great athletes may be able to earn a sports scholarship, while academically gifted students will be eligible for academic scholarships. Parents and donors need to carefully monitor the requirements for this type of aid to see whether a child could qualify for this assistance.

Private vs. Public Education

Of course, private schools cost a great deal more than public ones. Parents and donors for students who will be attending a private institution must be prepared to contribute substantially more to those plans than they may for children who will attend public or vocational places of study. As with the age difference, the cost difference of various type of schools may shape how donors decide to allocate their contributions among beneficiaries.

The State Tax Factor

Donors who are able to take a state tax deduction for their contributions are making a bit less of a sacrifice than those who cannot. Therefore parents of students who need contributions into their accounts may be more successful at requesting contributions from in-state donors than those who live elsewhere. Not all states have state-tax benefits for 529 plans, so check before you count on this option.

The Estate Tax Factor

Wealthy donors who are typically ineligible for state tax or other standard deductions may be more interested in finding ways to reduce their taxable estates. Supporting 529 plans gives them an ideal opportunity to gift large amounts of money to beneficiaries because they allow donors to deposit amounts equal to 5 years of gift tax exclusions in a single year. Therefore a married couple who files jointly could drop $140,000 into a single account in 2014, since the exclusion amount is $14,000 (X 2 X 5). This is, in fact, the easiest and most direct manner for wealthy taxpayers to reduce their taxable estate outside of making charitable contributions.

The Bottom Line

Saving for college is typically one of the major financial hurdles for most families. Using these strategies can lighten the burden in many cases and help students realize their academic goals. For more information on saving for college, consult your local student financial aid officer or financial advisor. In addition, read our tutorial on 529 plans and also check out Stop Procrastinating! Enroll In A College Savings Plan and Crass (But Effective) Ways to Build a College Fund.

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