Using College Savings Plans To Combat Rising Education Expenses

Randall J. Richard
Tuesday, October 1st, 2019
Posted in: Education Funding
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The costs of a college education continue to rise every year.

In fact, when adjusted for inflation, the average tuition costs at both public and private four-year colleges have nearly tripled since 1971. When room and board is combined with tuition fees, the average four-year private college now costs $42,419 per year. For many families, those numbers can seem daunting.

Balancing the rapidly increasing costs of college with your family’s financial goalsrequires careful financial planning and smart investments. To prepare for the financial impact paying for college could have on your family, you may want to consider investing in a 529 college savings plan.

The Benefits Of 529 College Savings Plans

529 plans offer your family many financial advantages, including:

  • Tax-free growth: You don’t have to pay any income or capital gains taxes on money earned by the plan, provided it’s used to pay for qualified college expenses.

  • Transferability: If the child or loved one you initially designate as the beneficiary of the plan chooses not to attend college or does not need all the funds, you may transfer the plan to a different beneficiary.

  • Flexible spending options: You may use the plan to pay for necessary college expenses such as books and computers, and you may use the plan funds at any accredited college in the United States.

  • Multiple contributors: Any of your friends or relatives may contribute to the plan.

  • Tax benefits: Certain states, including Maine, allow you to deduct some of your contributions to 529 plans against your state tax burden. It’s important to note that deduction limits and benefits apply and vary by state.

You and your spouse may contribute a combined $28,000 annually on each beneficiary’s plan without needing to pay federal gift taxes. You and your spouse  may also make a combined five-year carry-forward contribution of $140,000 at one time and deduct as allowed for the five years after that.  If contributing as an individual, the limits are $14,000 per year or $70,000 for a five-year carry-forward contribution.

What To Look For In Your 529 Plan

You have many different 529 college savings plans and options to choose from. It’s important to find one that best matches your needs.

As with all financial planning and investment options, you need to choose a plan that matches well with your financial goals. If your beneficiary is expected to attend college in a certain year, you should opt for a plan that will likely yield the most during that year.

It’s also advisable to select a plan that has strong underlying investment options. Some plans only allow you to invest in a limited portfolio. However, you may see better value putting your money in a plan that has a wide array of funds and fund managers. The service options provided by each plan are also something you should consider when making your selection.

Finally, if your family could be a target for litigation, you should choose a 529 plan that protects your investment from lawsuits or settlements. As you are allowed to invest in any state’s 529 plan options, your financial advisor may recommend an Alaska-based plan as the laws in that state provide the most comprehensive protection from litigation.

529 College Savings Plans: Important Considerations

You need to also consider the potential risks and regulations associated with 529 plans.

For instance, if you and your spouse exceed the contribution limit of $140,000 over five years, you will be subject to paying federal gift taxes. Also, most states cap the amount you and your family can invest in a 529 plan at approximately $300,000 per beneficiary, though these limits vary state-by-state.

Additionally, your plan’s funds need to be spent on qualified college expenses. Using these funds to pay for tuition, room and board are your safest bets to avoid any IRS scrutiny. While you are allowed to spend the funds on other associated costs such as books, computers and off-campus housing, it’s critical that you or your child obtain and keep receipts for all these expenses.

Finally, if you use the money to pay for non-qualified expenses, you are subject to tax penalties. Not only will you have to pay federal taxes on all the fund’s earnings when you withdraw your money for these non-qualified expenses, but you will also be subject to an additional 10% penalty. Because of this, if there is a remaining balance in the 529 planafter your child has completed college or if they decide not to attend college altogether, you should consider switching the beneficiary to another family member or loved one, or even to yourself if you decide to continue your education.

While there are some risks associated with investing in a 529 plan for your qualified college education expenses, these funds remain the most attractive college savings option for many families. The key to success with investing for your child’s education is to align your investment strategy with your long-term financial goals, and to begin your contributions early enough to see the value of your plan grow.