The cost of a college education continues to be shocking.
The average cost of tuition and fees for the 2017–2018 school year was $34,740 at private colleges, $9,970 for state residents at public colleges, and $25,620 for out-of-state residents at public universities, according to the College Board.
529 college savings plans were established in 1996 to make it easier for parents and others to save for education costs for designated beneficiaries.
Last year, Congress updated the regulations to include education costs at elementary or secondary public education. In 2018, up to $10,000 in qualified expenses for elementary and secondary schools can be withdrawn without incurring income taxes.
The primary advantage of 529 plans is that interest and capital gains on the contributions are tax free at the federal level and generally at the state level, as long as withdrawals are made for qualified educational expenses. These include tuition, associated fees, books and supplies, equipment, room and board, computers and related computer equipment.
State laws regulate the amounts that can be contributed; the total contribution can be as high as $380,000. There are no income constraints, such as there are for IRAs and 401(k)s. Individuals may contribute up to $15,000 per year to each beneficiary's 529 plan without incurring federal gift tax.
If you wish to make a contribution of more than $15,000 for a beneficiary in one year, you can treat the contribution as part of a five-year lump-sum allowance of up to $75,000 for gift tax purposes. Contributions are not tax-deductible.
Anyone can establish the account for a designated beneficiary, and a plan can be modified to include other family members at a later time.
Whoever purchases the plan is the custodian and controls the funds until withdrawal. The custodian does not have to allow the student any control regarding withdrawal of funds.
Naturally, if the designated beneficiary does not attend school, and funds are withdrawn for any purpose other than the qualified expenses previously referred to, income tax will be due on withdrawn interest/dividends earned, as well as a 10 percent tax.
Any state can establish a 529 plan. A designated beneficiary does not have to attend a school in the state in which the plan was created, nor is a person who establishes a plan limited to a specific state. He or she should establish a plan in whatever state is most beneficial.
Many savings/investment options are available in 529 plans, including mutual funds and exchange-traded funds. The best plans have a variety of investment options and minimal fees. FINRA, a financial industry self-regulatory body, has an expense analyzer that can help you compare and choose between plans.
Other good resources include Morningstar's reviews of the major 529 plans, which include ratings and Savingforcollege.com's "Best 529 plans of 2018."
One caveat is that when the time approaches for the beneficiary to attend college, the trustee should consider becoming more conservative regarding the portfolio structure. That is because the stock market could fall significantly at the time withdrawals must be made.
Although 529 plans have tax advantages, some savers might consider other alternatives, such as funding college out of a Roth IRA.
Principal can be withdrawn from a Roth at any time without penalty. At age 59 1/2, the donor can make withdrawals of any size without penalties. Also, if the beneficiary decides not to attend college, funds in a Roth plan could be withdrawn without the income tax penalties a 529 plan would have for funds withdrawn and spent on non-educational purposes.
Before committing too many assets to a 529 plan, you may want to discuss other options with your financial planner. See IRS Publication 970 for detailed information about 529 plans.