Redwood Wealth Management

A fee-only, independent advisory firm

529 Plans

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What is a 529 Plan?

Qualified Tuition Programs (known more commonly as 529 College Savings Plans or “529”) became the college savings vehicle in 2006 when Congress gave them permanent tax-free status for qualified distributions for higher-education expenses. IRS Publication 970 defines what qualified higher-education expenses are, but generally, they are any payment you make directly to the institution involving tuition, fees, books, supplies, equipment or room and board. IRS Publication 970 provides more detail.

A 529 is an investment account in which you can deposit the invested funds so they can grow over time tax-deferred, similar to an IRA. As long as your withdrawals are for qualified higher education expenses at an accredited institution, the gains within the account are free of federal and state tax. One accredited institution look-up tool is www.savingforcollege.com/eligibile_institutions. Generally, most colleges and universities in the United State are eligible for tax-free 529 withdrawals and even schools outside the United States are starting to become eligible.

There is no federal write-off available for contributions, but some states offer deductions to their own states 529 plan by in-state residents. 529 plans invest in a mix of funds based on the beneficiary’s age, generally known as Age-Based Funds, becoming more conservative as the child gets older and closer to entering college. These funds are similar to the retirement funds found in all 401k plans.
The most common questions we receive related to 529 plans include:

  1. What if my son or daughter receives a full scholarship to school? If your child receives a scholarship, you can take that amount out of the 529 and you only owe taxes on the gain for that amount. There is no penalty associated with the withdrawal. It’s kind of like you were investing in a “taxable” account all along, but still received the tax-deferral advantage.
  2. Should I save less for my own retirement so that I can pay for my son’s/daughter’s college tuition bill? No, absolutely not. You should never have to choose between saving for college and saving for your own retirement. Your child is much younger than you and can: work while in school, take on very low-interest debt through federally funded loan programs, or maybe a combination of both. Wrecking your own retirement for the sake of your child going to college isn’t a good idea.
  3. Should I do all of my college savings inside of a 529 plan? No, we prefer that parents save for about half of their expected college expenses in the 529 and the other half in a “taxable” account that has no restrictions or rules around it. That way, if you don’t need all of the money, you can go on vacation with your kids instead!
  4. Should I open a 529 account for each child? Yes, we think it’s easier to track this way and you can always move money from one plan to another. We recommend overfunding the oldest child’s plan so that you can move it down if need be.
  5. What is the difference between an UTMA and a 529 plan? See the chart below for the main differences between the 529 plan and the UTMA (Uniform Transfers to Minors Act) account, which is considered a minor’s account in Georgia. Some other states call them UGMA (Uniform Gift to Minors Act) accounts.
      1. tax deferrals
      2. potential state income tax write-offs
      3. tax-free withdrawals if used for qualified higher-education expenses

      2. 529 vs. UTMA

      Features 529 College Savings Plan UTMA
      High annual exclusion transfer tax limits (gift tax) 5 years of annual exclusions can be made up to $65k per beneficiary in a single year ($130k per married couple). Otherwise, the limit is $13k per year per beneficiary. Standard $13K annual ($26K per couple)
      High lifetime maximum contributions Yes, maximum varies by state (usually exceeds $200,000) No limit
      Account owner can change the beneficiary Yes No
      Control over Assets Participant (account owner – usually the parent) maintains control over distribution of assets for the lifetime Account owner’s (parent) control terminates when minor reaches age established under state law (generally 18 or 21). Deposits represent an irrevocable gift to the child.
      Contributions limited to income of participant No No
      Age limit for beneficiary None, which means adults can use 529s to save for their own higher education expenses 18 or 21
      Level of impact on financial aid when applying for college Low – counted as asset of parent or other account owner; not counted as student asset High – counted as student asset

      At the end of the day, the 529 account is a fantastic opportunity for you to save money for college education costs that allow:

      There are only two such accounts in the Internal Revenue Code that allow all three: HSAs and 529s. In addition, because the IRS doesn’t allow a lot of trading within the account, we at Redwood don’t charge for the accounts. We simply help our clients pick the most appropriate age-based fund and then track the balance so parents can ensure they’re meeting their goals.