Guess who’s back on the red couch?!?
I love making the trip to the northwest side of Indianapolis to join my friend Angela Ganote to discuss various financial related topics, although I’m sure the viewers will be glad to see me stop coming because every talk has been about inflation or now a decline in 529 balances 😀–if I’m not there then things will have gotten better.
I’m good with being a financial voice of reason (and confidence)during the current environment and I have no shortage of financial knowledge to share and help the viewers when things improve.
Let’s get to today’s segment…per the normal with live TV there’s never enough time to cover everything that I’d like. I’ll briefly mention the highlights and will spend some time on the talking points I wish I had more time for or we didn’t get to.
What Is A 529 Plan?
First:This wouldn’t be a financial blog without a disclaimer: while 529 plans are not an overly complicated investment vehicle, the implementation of a 529 plan within a financial plan presents a number of financial planning opportunities, investment decisions, and tax implications. While you can set up a 529 plan without working with a professional, I highly recommend you consult a financial advisor and/or tax professional to determine the appropriate amount of savings, how to invest, when to make changes, and how to use the funds when the time comes.
This is not meant to be an exhaustive explanation of 529 plans but I did want to hit many if the benefits and the rules to be aware of.
The short version: a 529 plan is a tax-advantaged savings/investment vehicle for educational expenses.
The longer version: 529 plans have a lengthy history–they started with the first prepaid college savings vehicle being created in 1986 in Michigan and in 1994 the income in these plans was ruled to be federal tax-exempt. Building upon this momentum for college savings, in 1996 Congress enacted section 529 of the Internal Revenue Code creating the 529 plan and in 2001 the Economic Growth and Tax Reconciliation Act catapulted the popularity of the plan.
It’s interesting to note that each state created its own 529 plan rather than there being one universal 529 program—the major differences between the state 529 plans are the custodian (what company holds the investments), the investment options, the expenses associated with the plan, and potential tax incentives for residents of the state to use its plan. Be sure to understand the rules and benefits for each state plan as you determine the right one to use.
Over the years the 529 plan has only seen a few changes.
When it was first created, the 529 plan allowed for savings to grow tax deferred and if used for qualified higher educational expenses, the proceeds would be tax-free BUT if the funds were not used for qualified higher educational expenses, the earnings would be subject to a 10% penalty, along with income taxes–this is still true today. In addition to the tax deferral and tax-free qualified distributions, some state 529 plans allowed (and still do) for state tax advantages. For example, in Indiana if Hoosiers use the CollegeChoice Direct 529 plan they are able to receive a 20% state tax credit up to a maximum of $1,000 (so after $5,000 of annual household contributions the credit is maxed out).
Recently, the 529 plan has received some welcome extensions of its benefits. In 2017, qualified educational expenses were extended to allow for up to $10,000 in private school grades K-12. In 2019, 529 plans were granted the flexibility to allow for up to a lifetime $10,000 of student loan payments, with an additional $10,000 in student loan payment for siblings of the beneficiary. In that same bill, 529 plans were also extended to include apprenticeship programs, which I love because we could have a much deeper conversation about what is the right educational path for people–I don’t think we should force four year college on everyone nor should we shame individuals from going into a trade…that’s a talk for another day.
A couple of nuiances to be aware of:
- You are limited in the number of times you are able to change the investment allocation each year. Unlike other investment vehicles you are not currently able to change investments whenever you would like.
- You are able to change the beneficiary of the 529 but are also limited in who the new beneficiary can be, although it’s most likely the desired new beneficiary for most will be allowed, and how often you can change the beneficiary.
What To Do
Ok, now that we have a good understanding of what a 529 plan is, let’s take a look at what those with 529 plans might want to be considering in the current state of the stock market and economy. This is not a comprehensive list, rather a starting point for discussions.
If you are getting ready to start making distributions:
- if you have additional savings that could be used to allow the investments to recover consider using cash that is earning nothing to cover expenses this year. Yes, I’m aware that not everyone is flush with cash but for those fortunate enough to be in this situation it is a viable option so I won’t leave it out.
- if you are not able to avoid selling investments to cover expenses, consider selling the investments that are down the least to allow the others more time to recover. One thing to avoid is anchoring the growth of your portfolio to what has happened this year—if you have had a 529 plan for years there is a good chance that you are still in the green, just not as high as you were last year.
- consider using the lifetime $10,000 student loan payment option and leverage a student loan to allow the investments more time to recover…paying the loan off in the future with proceeds from the 529 plan.
If you have kids going to college in the next few years:
- Plan your distribution strategy now.
- Evaluate if any of the options in the above scenario should be considered.
- Consider building a cash savings to complement the 529 in case we experience a similar scenario when it is time for you to start taking distributions.
- Determine if an allocation change now, or soon, is appropriate. A best practice would be to have the first couple years of expenses in the more conservative options within the 529 plan.
- Consider directing new contributions to more conservative funds and allow the investments already in the account stay invested for later years.
- If you are using an age-based investment option, review the allocation and make sure it matches where it needs to be given your needs and situation. An age-based investment option gets more conservative as the child gets older, which makes sense. However, in a time like now when even bond funds are down the bond allocation in the age-based fund may not be the best option.
As you can see the 529 plan is a great vehicle for education expenses but there are a lot of decisions to be made when using them. I cannot stress the importance of working with a professional to help determine the right amount to save into the 529, how to invest the funds, when to make investment changes, and how the 529 plan fits into the entire education plan (I don’t think the 529 plan should be the only funding vehicle for education…that’s just my two satoshis though (satoshis = crypto cents)).
With the tax deferral, potential for investment growth, tax-free distributions, state tax credit/deductions, and ability to transfer unused funds/accounts to other beneficiaries the 529 plan is a great option for including in an education savings plan–the level at which it participates depends on your situation.
Disclaimer: Nothing on this blog should be considered advice, or recommendations. If you have questions pertaining your individual situation you should consult your financial advisor. For all of the disclaimers, please see my disclaimers page.