The cost of higher education has risen dramatically over the last 10 years, with four year college tuition increasing at an annual average rate of 5%, outpacing inflation over the same time period by 3.4% per year. The national average cost of attending a four-year public college is now over $28,000 per year and exceeds $59,000 for private-colleges. Fortunately, establishing and funding a 529 plan early can set families and students up for future success.
1. Benefits of a 529 Plan
529 plans are tax-advantaged savings vehicles which allow families to put money away for college (and K-12 as of 2018) and allow the invested funds to grow tax-free until they are needed for qualified education expenses like tuition, room and board, computers and textbooks. The benefits go beyond tax-free growth, including parental control of the assets, the ability to transfer leftover plan funds to other family members, and certain estate planning benefits.
2. Choose Plan Providers Carefully
State-sponsored plans are readily available and many include additional matches and tax benefits for their residents. A Morningstar study found that, on average, 529 investors who received tax breaks reduced their state tax bill by $87 for every $1,000 they saved, that’s an equivalent of an 8.7% return. However, some state’s plans have high costs, poor investment options and few tax incentives. Look for plans, state-sponsored or private, with quality investment options and low administration fees.
3. Choose the Investments Carefully
In selecting the underlying investments of a plan, there will typically be a variety of options with a range of associated fees. Look for options with low-cost, age-based allocations or funds. These age-based selections will manage how the plan is invested over time, automatically reducing the allocation to equities and increasing the allocation to bonds as the beneficiary approaches college-age.
4. Who Owns the Plan Matters
Distributions from grandparent-owned 529 plans may be counted as income to the student on their financial aid application and can actually reduce their eligibility. If grandparents have already established a 529 plan, those assets can be saved until senior year after the final year’s application has been filed. 529 plans held by parents are counted as assets of the parent and do not have the same effect on financial aid.
5. The Power of “Superfunding”
Contributions to the plan are treated as gifts to the beneficiary, so $15,000 per individual or $30,000 from a married couple can be contributed without triggering a gift tax. However, 529 plans have a unique feature which allows pre-funding of up to 5 years, amounting to $75,000 or $150,000 in a single year. This “superfunding” maximizes compounding over an 18-year time horizon, potentially resulting in an ending account balance nearly 50% higher at the end of 18 years compared to equal annual contributions.
Superfunding provides an additional estate planning benefit to grandparents or other family members looking to reduce their taxable estate by providing a tax-free way to make a significant gift early on in the beneficiary’s life and allowing assets to grow outside of their estate.