The Pros, Cons and How-tos of 529 Plans

Feb 22, 2019

Wealth Insight: How to weigh the right plan for your child'south education plans.

What do I need to know about 529 plans?

Whether your child is in middle school or a newborn, information technology's a slap-up time to retrieve about how you lot'll cover her instruction costs. For families with higher income and net worth, Section 529 plans are the almost popular vehicles to fund not just college tuition, merely private kindergarten through loftier school expenses also.

529 plans are popular mainly thanks to:

  • Tax advantages of contributions and distributions

  • The amounts you may deposit on a yearly basis

  • The control the contributor may take in the plan

529 program, divers

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. They're sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.1

How much can we contribute to a 529 plan? (And what about souvenir taxes?)

Different any other gifts, you can retain control over your gift with no "bad" estate tax consequences.

If y'all're a unmarried filer, you can contribute upwardly to $fifteen,000 per year without incurring gift taxes. And if y'all're a married couple filing jointly, the amount jumps to $30,000 per year. Beyond that corporeality, you'll accept to pay souvenir tax.

At that place is, however, a way that you lot can contribute $75,000 in i year ($150,000 for married joint filers) and have that gift treated as if it were made over 5 years at $15,000 ($30,000) per year, and free of gift taxes. You can't contribute any more until 5 years take passed, unless you're willing to pay gift taxes, or unless the annual gift tax exclusion gets increased.

Allow's look at the pros and cons of 529 plans.

529 Pros

Income tax benefits

  • When used for college or Thousand-12 qualified expenses, earnings are non field of study to federal income tax.
  • If not used for qualified expenses, federal income tax on the earnings is deferred until distribution.
  • Many states offer a state income revenue enhancement deduction for contributions to those states' 529 plans, making it attractive for their residents to choose their plan over those offered by other states. Some states even offer revenue enhancement deductions on contributions to other plans.

Flexibility

  • Unlike whatsoever other gifts, you tin retain control over your gift with no "bad" estate tax consequences. You tin can likewise change the casher to certain family members with no tax consequences, or take the funds back (subject to a 10% additional tax on earnings).
  • Parents are not the only ones who can gear up upwards 529 plans for their children. Grandparents, siblings or fifty-fifty friends can contribute to a 529 programme even if they are not the account owner.
  • You can contribute to a 529 program in any state, not just the one y'all live in. For instance, if you live in Pennsylvania, and Utah's plan volition exist more benign than Pennsylvania's, you lot're permitted to apply a Utah 529 even though yous don't alive at that place.

Gift tax

You can contribute using the annual exclusion for 5 years (front-loading). Example: You contribute $75,000 to a 529 business relationship for your girl in 2019 and treat the contribution equally made using your $15,000 annual exclusions for 2019, 2020, 2021, 2022, and 2023. The advantage of front-loading is that earnings can brainstorm to build tax-gratis faster than if yous made carve up contributions each yr.

529 Cons

x% additional income tax

If not used for college expenses, in that location is a 10% boosted tax on earnings.

Ordinary income

If non used for qualified expenses, all earnings are taxed as ordinary income (fifty-fifty if the "actual" earnings were capital gains).

Higher costs

The management fees for a 529 account are college than the fees for comparable mutual funds.

Less flexibility in investments

The investment vehicle can be changed only one time per year, and the choices are express to certain managers.

No disbelieve on gifts

If an individual is choosing betwixt a gift of an nugget that tin can exist discounted (such every bit fractional interest in real estate) and a souvenir to a 529 programme, he/she can transfer "more than" through gifts of real estate (which tin exist discounted).

Decreases ability to reduce estate

  • If you make almanac gifts to a kid (rather than to 529 account), you can pay college expenses out of your ain pocket, and thereby, reducing your estate. Note: In this case, your manor is reduced by annual gifts and past college expenses.
  • If you make annual gifts to a 529 account for a kid and pay college expenses from the 529 account (rather than out of your own pocket), your estate is reduced by annual gifts, but not by college expenses.

What to consider before choosing a 529 programme.

The size of your estate

The younger the kid, the better; this gives you more time for tax-complimentary buildup.

If you lot fall in the moderately wealthy category and are non making almanac exclusion gifts, there'southward no estate disadvantage and you go the income revenue enhancement benefit (assuming funds are used for higher expenses), as well as a possible manor tax do good (because the manor is reduced by the almanac gifts to the 529 account).If you're considered "moderate means," you lot may exist more focused on saving for retirement than your child'south education, and a 529 programme may not be ideal for you. In addition, a 529 program may affect your child'due south ability to qualify for financial aid (federal, state or the educational institution'due south).

The age of the children

The younger the child, the better; this gives you more time for tax-free buildup.

Equalization among children

Use this with caution. Example: Grandma has given $500,000 to her ten-yr-onetime grandchild and has used her entire unified credit on this and other gifts. Another grandchild is born and now Grandma would like to endeavor to make her gift to this child equal to the other's gift. Grandma tin use her annual exclusions to contribute $xv,000 to 529 accounts for both the 10-twelvemonth old and the newborn, but then direct the entire distribution to the newborn down the road.

How to select the correct plan for your family'due south needs.

And so, you've decided a 529 program is the style to become. Now — how do you select the right 1? They're non yet, and y'all don't take to choose the ane your country sponsors. Allow'south have a look at the relevant factors.

Residence

The first identify to wait is your home state. Some states offer special tax benefits to their residents (like a state income tax deduction for contributions to the 529 plan of that state) and/or lower fees for residents.

Feesii

Fees can accept a major impact on the performance of a 529 account. Expect for plans with low fees — anywhere from 0.xiii% to 0.89% is good. States with plans in this range include Utah, New York, Iowa, Michigan and Nevada.

Choice of funds

While fees are important, dissimilar 529 plans have different kinds of funds available. It's crucial to examine these choices and rails record of the funds.

Creditor protection

If creditor protection is a major result, exist sure to review this aspect of each programme. Alaska and New York (and perhaps other states) have special provisions for creditor protection, subject field to certain restrictions.

Contribution restrictions

States have contribution limits ($300,000 and upwards in most states), and others raise their limits each year to keep up with ascension college costs. Some plans also may have a contribution limit, both initially and each year.

A real-life 529 program assay

Nosotros compared two plans2, three to find out where a hypothetical family unit, the Chens of Washington, come out when considering a program for Riley, their toddler. Nosotros took a look at the specifics of two state plans – their home land of Washington, and Utah's programme, which is a popular option.

Download the full commodity to meet the details of our analysis.

Download PDF

Talk with your financial advisor when you're ready to consider a 529 plan. Yous'll accept a lot to recollect nearly before determining whether a 529 plan is right to finance your children's education and and then finding the plan that's right for you. Your fiscal advisor can help you structure a plan that best fits your needs.

Legal Note

1 Securities and Commutation Commission, "An Introduction to 529 Plans" May 29, 2018
2 Fee range is approximate equally they change periodically.
3 my529.org (Utah Educational Savings Plan). Accessed on January nine, 2019 at savingforcollege.com/529-plans/utah/my529

Legal Note

The material included herein is based on the views of SIMC. Statements that are not factual in nature, including opinions, projections and estimates, assume sure economic conditions and industry developments and constitute only current opinions that are subject to change without observe. Zilch herein is intended to be a forecast of future events, or a guarantee of future results. This presentation should not be relied upon past the reader as research or investment advice (unless SIMC has otherwise separately entered into a written agreement for the provision of investment advice).

Neither SEI nor its affiliates provide tax communication. IRS Round 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that whatsoever revenue enhancement advice contained in this communication was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding revenue enhancement-related penalties under the Internal Acquirement Code or (two) promoting, marketing or recommending to some other party whatever matters addressed herein. Yous should seek advice based on your item circumstances from an independent tax counselor. The data contained in this communication is non meant to substitute for a thorough estate planning and is not meant to be legal and/or estate advice. It is intended to provide you with a preliminary outline of your goals. Please consult your legal counsel for additional information. This is intended for educational purposes and not meant to exist relied upon equally investment advice.

Run across your investments through a new lens

Personal wealth management for high-net-worth individuals

If you're like other wealthy individuals, you might be surprised at the gap between your goals and the wealth you've set aside to accomplish them. Nosotros work with a grouping of highly successful entrepreneurs, CEOs, executives and families to marshal investments with personal objectives.

Personal wealth direction

Photo: a client meets with advisor

More than reading for loftier-net-worth families

Your financial success supports all facets of your life. Our Knowledge Middle inquiry and commentary speaks to your needs and interests.

Back to Top