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Saving for college begins with a 529 plan

Posted by Shanna Tingom, AAMS® on May 29, 2017 7:00:59 PM

college-1.jpgIf there was one hot button in last year’s election, it was how the average American family can afford to pay for college. For many, it is difficult to impossible, taking time and patience to find college loans and scholarships for a post-secondary education but if you start early, you can reap the benefits of investing with a 529 Plan. Also called a Qualified Tuition Program (QTP), states, including Arizona, have established 529 college savings plans to help students and their families invest in education.

The earlier you can start saving for your child’s education, the better for the return on the investment. If this sounds overwhelming, as it does for many families that I meet, visit Save4CollegeAZ.com where you can create your own FREE College Planning Report.

Benefits of a 529 Plan

Many parents and grandparents don’t understand the benefits of a 529 plan, not only for their college-bound child or grandchild, but for their own financial planning.

  • Grandparents can establish a 529 plan with a grandchild as beneficiary.
  • No tax on the growth of the account making it especially important to find the right investments for the principal (initial) investment.
  • No longer need to select a specific school at the time the account is established. Funds can be applied to a variety of post-secondary education institutions.
  • No tax due on the distribution from a 529 plan unless the amount distributed was greater than the beneficiary’s adjusted qualified expenses, according to IRS Pub 970.
  • Certain states offer a state income tax deduction for 529 contributions.
  • Beneficiaries can easily be changed between family members.

While there are benefits to saving in a 529 Plan for your college-bound family member, you can’t wait until they’re a double-digit age to start saving. The earlier you save, the better. The reason is because of compound interest and return on investment.

What is compound interest?

The longer money can stay invested without taking withdrawals, the better the rate of return. It’s called compound interest or compound returns and here’s how it works:

Say you open an account with $10,000 at 5% interest. That’s $500 of interest earned so the closing balance is $10,500. Then the interest is earned on the principal ($10,000) + interest ($500) at a rate of 5% ($525) for a new closing balance of $11,025. The account continues to earn interest over time so the longer you’re invested, the better the rate of return.

Graphic from Investopedia http://www.investopedia.com/terms/c/compoundinterest.asp

Working with a financial advisor to make investment decisions that are aligned with your financial goals. This may include changing allocations or investments over time.

Let’s take a look at a hypothetical scenario.

Often I talk to people who think they have to wait until they die to leave money to children or grandchildren but that’s simply not the case. Let’s say you have a grandson and want to help him in the future. You invest $10,000 in a 529 college savings plan with eight year old Grandson as beneficiary, choosing appropriate investments to be sure there’s growth in the account over the next 10 years.

Grandson chooses not to go to college and instead begins working post-high school. At the age of 30 he gets married and has a child. Grandson can use the 529 plan for his own education OR the beneficiary can be updated Great-Grandson and continue to grow.

For the sake of this example, let’s say the plan has an 8% rate of return and over 10 years grew to $21,589. If left for another 18 years at just a 7% return, the value of the account when Great-Grandson reaches college age will be $72,969 AND it’s all tax-free!

Should the beneficiary choose not use funds for college, they can choose to withdraw funds, pay taxes on the income and incur the 10% penalty.

Tax Consequences

While the funds grow without state or federal taxes being charged and withdrawal for qualified expenses is tax-free, there may be gift tax consequences. There is no annual maximum contribution limit but if you contribute more than $14,000* annually ($28,000* for married couples), you may be subject to a gift tax.

To avoid paying a gift tax while at the same time contributing to a 529 plan, you may contribute up to $70,000* in one year ($140,000* for couples) if you don’t make any other gifts to the beneficiary of the 529 college savings account, that year or any of the following four years. This can be included in a larger financial plan that you establish with your financial professional.

*Contribution amounts may vary by state.

Qualified Expenses for 529 Plan Distribution

While your student may want to use their 529 Plan for food and fun, there is a strict definition of expenses that includes tuition, room and board, books, supplies, and equipment required by the school. If student is part-time, the distribution amounts may vary.

Burgers, beverages, new laptops, and car payments don’t count and you will be taxed at your regular rate if 529 funds are used for these types of expenses. The penalty may include state or federal income taxes and an additional 10% early withdrawal penalty.

What makes the Arizona 529 Plan different?

There are two distinct differences with Arizona’s 529 plan compared to other states:

  1. You can use ANY state’s 529 plan and still get the state tax deduction.
  2. Change the beneficiary from one child to another child, parent, niece, or nephew.

That means if there is a plan performing better than Arizona’s 529 plan, you can use that state’s plan and maximize the tax free growth on your principal investment. If one child doesn’t use the 529 plan, you can also opt for another qualified family member to use the money for their post-secondary education.

Need more information on College Planning? Visit Save4CollegeAZ.com and contact Shanna Tingom at Heritage Financial Strategies 480-397-1184.

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DISCLAIMER: Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses, summary prospectuses and 529 Product Program Description, which can be obtained from a financial professional and should be read carefully before investing. Depending on your state of residence, there may be an in-state plan that offers tax and other benefits. Before investing in any state's 529 plan, investors should consult a tax advisor. If withdrawals from 529 plans are used for purposes other than higher education, the earnings will be subject to a 10% federal tax penalty in addition to federal and, if applicable, state income tax.

Topics: Financial Planning, College, College Tuition