Tax Advantaged Educational Savings Plans – Are they for you?
Education costs continue to rise and the task of saving for college or trade school becomes more daunting each year. Fortunately, there is a village of supporters who want to help a child save for their education, including the ancillary expenses required to have a full and enriching educational experience. One of the most efficient and effective ways to accomplish this savings goal is by using a 529 plan.
529s are education savings plans operated by a state or institution and are designed to help families set aside funds for future education costs. They are named after Section 529 of the Internal Revenue Code, and were created in 1996. These state-affiliated savings plans may be used for costs of qualified educational institutions nationwide. New perks to the 529 also make these funds available for K-12 tuition at public, private, or religious schools, tax-free, up to $10,000 each year per beneficiary.
The location of your 529 plan does not limit your choice of school in most plans. For example, you can be a Vermont resident and invest in a Michigan savings plan or vice versa. Every state plan has different tax benefits for residents, various fee structures and a host of investment options, so it is a good idea to shop around. Michigan residents, for example, receive a state income tax deduction for up to $5,000 of savings contributions for singles ($10,000 for couples) with a maximum contribution limit of $500,000, whereas Indiana has a maximum contribution limit of $450,000 and Indiana residents receive a 20% tax credit for annual contributions up to $5,000.
Nearly every state has at least one plan available and some have more than one. It’s important to research the features and benefits of each plan, since not all states allow for an income tax credit or deduction for contributions to the plan. Shop around if your state plan doesn’t allow for these and find a low cost, high performing plan. Ask your SYM advisor or check out www.savingforcollege.com to see 529 plans ranked by state.
Inside the 529 plan, contributions will grow tax free, making it a smart saving strategy for education expenses. When funds are withdrawn from 529 plans for qualifying education expenses, they are tax-free. If funds are withdrawn for purposes other than qualified education costs, the earnings are subject to income tax along with a 10% penalty. Qualified education expenses include tuition, fees, books, supplies and equipment.
Now that you have a handle on the basics, here are some of the additional benefits of using a 529 plan.
Federal Tax Benefits- Although contributions are not deductible on your federal tax return, your investment grows tax-free. The distributions to pay for the beneficiary’s qualified education expenses are tax-free.
State Tax Benefits- As mentioned previously these vary by state, if the plans in your state are lacking take advantage of 529 plans from other states. Good options are lower fee plans like the Michigan or Utah plans. Watch out for advisor sold plans, as many times they include additional fees for management or investments. Solid advice may add value by the time funds are needed, but make sure you are getting value commensurate with fees paid. If you live in Michigan and a broker suggests a Virginia 529 plan, for example, the investments would need to be wildly more successful to forego the 4.25% Michigan state tax deduction. Virginia’s broker-sold plan also includes up to 4.25% initial cost and expenses of 0.41% – 2.13%. Compare that to Michigan’s direct-sold plan where you receive a state tax deduction, and total expenses run between 0.20% – 0.30%. As a fee-based advisor, SYM Financial Advisors never uses broker-sold plans and recommends the low-expense solution that we believe is the most advantageous for our clients’ state of residence.
Simplified Tax Reporting- You won’t receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals from the account.
Donor Control- The donor stays in control of the account with a few exceptions to the treatment of the funds. The named beneficiary has no rights to the balance of the account. The donor has complete control to decide when withdrawals are taken and for what purpose. Most plans allow the donor to reclaim the funds at any time; however the earnings portion of any non-qualified withdrawal will be subject to income tax and an additional 10% penalty. Compare this level of control to a custodial account under the Uniform Transfer to Minors Act (UTMA) and you will find the 529 plan gives you much more say in how your funds are used.
Flexibility- If you want to change investments, you may do so each year in most 529 plans. Also, you may rollover the account to another state’s program as long as there has not been another such rollover for the beneficiary in the last 12 months. This is useful if you change your state of residency and want to take advantage of a state income tax deduction or credit. You may replace the account beneficiary with another qualifying family member. This is useful, for example, when moving funds between siblings or passing education funds down to grandchildren.
Open and Unrestricting- Everyone is eligible to contribute to and participate in a 529 plan. Many state plans allow beneficiaries to have balances of up to $500,000, so contributions can be made from family, friends and beyond. There are no income limitations or age restrictions. Thinking about going back to school in the future? Then, consider setting up a plan for yourself.
Disclosure: SYM Financial Corporation (“SYM”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about SYM, including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request.