Getting into college is tough, but so is paying for it! College costs have risen well ahead of inflation for decades, and this year the state of California is advising families to budget over $34,000 per year for young scholars lucky enough to gain admission to one of the Universities of California (the “UCs,” as we like to call them).
Families saving for college have a number of options, but the best deal overall is the education savings plan named for section 529 of the tax code. 529 plans allow parents and grandparents the option of saving “after-tax” money in special accounts where dividends and capital gains accumulate tax free. These earnings are never taxed as long as the funds are used for legitimate educational purposes in institutions of higher learning, interpreted fairly broadly. And there are no income eligibility limits, as there are with tax-deferred savings vehicles like Roth IRAs.
Most parents of kids headed for college have at least heard about 529 accounts, but here are a few 529 advantages that you may not have considered.
- Control: 529 plans are owned by the parent, grandparent, aunt, godparent, etc. who opens the account, not the student who is going to college. Why is this important? In a word, control. The owner can pull the plug if Junior decides to major in Partying 101.
- Financial Aid advantage: Another, less well known advantage of this control comes into play when families are trying to qualify for need-based financial aid. Colleges look first to the assets of the student, and insist on taking a larger percentage of the student’s assets, before they look at the parents’ assets. Some of the other college savings accounts (UTMA/UGMAs, for instance) are typically held by students, so they are swept up quickly when tallying whether a family qualifies for aid. 529 plans owned by parents are still considered parental assets. And 529 plans owned by a grandparent or other family member are not counted when calculating a student’s aid eligibility (WARNING: this is not the case when actually using the money in subsequent years, as distributions are treated as student income).
- Account beneficiary flexibility: Many parents tell stories of opening 529 plans and signing up for the best preschool as soon as the child enters the world. But people who plan on having children can open 529 plans benefitting themselves long before those cute little beneficiaries are born, and then switch the beneficiaries sometime along the way. For people who don’t have children until later in life, this is a great way to increase tax deferred savings. If you wind up not having children, you can go to school yourself, or contribute to the expenses of your grateful siblings’ children.
- Destination flexibility: Maybe your progeny just can’t get excited about State U or even Posh Private U, and instead decides to hie off to Edinburgh or Toronto or Melbourne for their higher education. Besides having distinctly lower tuition, many international schools are very happy to accept your 529 Plan savings in paymentSavingforcollege.com has a good tool to find out if your child’s destination of choice is on the list. Just type in “FC” (for foreign country) in the “state” box to check them out.
So if college tuition is on your horizon, or you want to win that Grandparent of the Year award, check out 529 plans. They are sponsored by almost every state in the country, and some states offer additional tax incentives for residents. But you don’t have to pick the state plan where you live. You can live in CA, send your child to college in Vermont and use the excellent Utah Educational Savings Plan as your investment vehicle. Here ‘s a list of some other “best of the best” 529 plan offerings.
Learn about how a 529 plan can also be a key part of your family’s gifting strategy in our blog Five Hidden Gems of 529 Plans.
