Read Beth's Article from the February 2013 Issue of Mindful Money magazine
|
College Funding: Selecting a 529 Plan
Most parents with offspring setting their sights on four years at a college campus sometime in the future are familiar with 529 plans, which allow the contributor to sock away funds which can be later withdrawn to pay for qualified tuition and expenses. But which plan should a parent choose given so many options? These days, even within one state there are often multiple plans.
The key to deciding on a college funding strategy, like many other financial decisions, is to know yourself and your situation. Faced with so many choices, parents sometimes decide to do nothing while thinking it over for a few months. The problem, of course, is that your cute 2-year-old is suddenly getting their braces off and entering high school. Parents need to select a savings strategy and feel comfortable enough with their decision that they remain committed to their plan until the day their child loads up their posters, IPods, and pillows and moves into a dorm room.
To decide on a plan, examine your family’s specific situation. Some state-sponsored 529 plans allow a tax deduction for annual contributions up to a certain limit. No federal tax deduction is available with a 529 contribution, but earnings grow tax-deferred and owners can take tax-free withdrawals to pay for qualified college expenses. For example, Georgia allows a tax deduction against state income on up to a $2,000 contribution. Residents do not have to itemize to claim the deduction, and there is no income cap on the deduction for high wage earners. By comparison, Idaho’s plan allows a deduction of up to $4,000 per year by an individual, and up to $8,000 per year by a married couple filing jointly. If a healthy tax benefit is available in your state, you may feel confidant using your state’s 529 plan.
A smaller percentage of states even offer “tax parity”, where the plan allows a tax benefit to participants who have made contributions to accounts outside of the home state. Kansas offers this benefit, with a $3,000 individual or $6,000 joint contribution to an in-state or out-of-state plan qualifying for the deduction. If there is no state tax deduction available, you may decide to look further. Or perhaps, you are lucky enough to live in a state with no income tax like Alaska or Florida.
If taxes are not the issue, consider what type of investor you are. Do you like to read the financial press and love managing your own retirement plan? Perhaps you’re the type who has actually read every scrap of literature on your 401K choices. A “direct” plan with the low fees and no advisor acting as the middleman may be exactly what you want. If it has been so long since you opened your statement, or you can’t remember if the balance is tied up in stocks or bonds, perhaps you would sleep better investing in an advisor managed 529. To cater to both types of investors, many states now offer both distribution channels.
Other considerations include the available investments within each plan and, of course, expenses and fees. Typically, 529 plans use age bands to progressively move a child’s balance from a more aggressive allocation of stock and bond funds to a more conservative split as the student approaches college. Some states limit choices to one or two age-based tracks, while others such as Maine currently offer up to 6 age-banded portfolios. Just be aware that there can be a wide divergence among age-band allocation percentages across plans. Some may have a hefty stock exposure when the child is a few years from college, while others may largely be invested in bond funds at the point. However, many plans became more conservative after the recent financial turmoil.
For investors choosing not to use pre-selected portfolios, a plan that offers a range of choices from small-cap to international investments to differing maturities of bond funds may matter to you more than low-fees. The widest range of investments is still most often available through the advisor-directed plans.
These days, states have also added choices of conservative, moderate and aggressive portfolios within each age band. If you stayed up at night worrying about your retirement plan during the worst of the financial downturn in 2008 and 2009, pick an asset allocation you can live with if the market takes another sudden drop. Remember, plans only allow a change of asset allocation once each year unless you are adding or changing a beneficiary.
One last consideration concerning 529 accounts is the effect on your child’s eligibility for student financial aid. As of 2012, the federal formula for calculating need-based aid if the parent owns the 529 includes 5.6% of plan assets in the student’s expected family contribution or EFC. Just remember when applying for school-specific aid, some colleges may have their own formula for determining which assets and what amounts figure into the computation.
Most parents with offspring setting their sights on four years at a college campus sometime in the future are familiar with 529 plans, which allow the contributor to sock away funds which can be later withdrawn to pay for qualified tuition and expenses. But which plan should a parent choose given so many options? These days, even within one state there are often multiple plans.
The key to deciding on a college funding strategy, like many other financial decisions, is to know yourself and your situation. Faced with so many choices, parents sometimes decide to do nothing while thinking it over for a few months. The problem, of course, is that your cute 2-year-old is suddenly getting their braces off and entering high school. Parents need to select a savings strategy and feel comfortable enough with their decision that they remain committed to their plan until the day their child loads up their posters, IPods, and pillows and moves into a dorm room.
To decide on a plan, examine your family’s specific situation. Some state-sponsored 529 plans allow a tax deduction for annual contributions up to a certain limit. No federal tax deduction is available with a 529 contribution, but earnings grow tax-deferred and owners can take tax-free withdrawals to pay for qualified college expenses. For example, Georgia allows a tax deduction against state income on up to a $2,000 contribution. Residents do not have to itemize to claim the deduction, and there is no income cap on the deduction for high wage earners. By comparison, Idaho’s plan allows a deduction of up to $4,000 per year by an individual, and up to $8,000 per year by a married couple filing jointly. If a healthy tax benefit is available in your state, you may feel confidant using your state’s 529 plan.
A smaller percentage of states even offer “tax parity”, where the plan allows a tax benefit to participants who have made contributions to accounts outside of the home state. Kansas offers this benefit, with a $3,000 individual or $6,000 joint contribution to an in-state or out-of-state plan qualifying for the deduction. If there is no state tax deduction available, you may decide to look further. Or perhaps, you are lucky enough to live in a state with no income tax like Alaska or Florida.
If taxes are not the issue, consider what type of investor you are. Do you like to read the financial press and love managing your own retirement plan? Perhaps you’re the type who has actually read every scrap of literature on your 401K choices. A “direct” plan with the low fees and no advisor acting as the middleman may be exactly what you want. If it has been so long since you opened your statement, or you can’t remember if the balance is tied up in stocks or bonds, perhaps you would sleep better investing in an advisor managed 529. To cater to both types of investors, many states now offer both distribution channels.
Other considerations include the available investments within each plan and, of course, expenses and fees. Typically, 529 plans use age bands to progressively move a child’s balance from a more aggressive allocation of stock and bond funds to a more conservative split as the student approaches college. Some states limit choices to one or two age-based tracks, while others such as Maine currently offer up to 6 age-banded portfolios. Just be aware that there can be a wide divergence among age-band allocation percentages across plans. Some may have a hefty stock exposure when the child is a few years from college, while others may largely be invested in bond funds at the point. However, many plans became more conservative after the recent financial turmoil.
For investors choosing not to use pre-selected portfolios, a plan that offers a range of choices from small-cap to international investments to differing maturities of bond funds may matter to you more than low-fees. The widest range of investments is still most often available through the advisor-directed plans.
These days, states have also added choices of conservative, moderate and aggressive portfolios within each age band. If you stayed up at night worrying about your retirement plan during the worst of the financial downturn in 2008 and 2009, pick an asset allocation you can live with if the market takes another sudden drop. Remember, plans only allow a change of asset allocation once each year unless you are adding or changing a beneficiary.
One last consideration concerning 529 accounts is the effect on your child’s eligibility for student financial aid. As of 2012, the federal formula for calculating need-based aid if the parent owns the 529 includes 5.6% of plan assets in the student’s expected family contribution or EFC. Just remember when applying for school-specific aid, some colleges may have their own formula for determining which assets and what amounts figure into the computation.
