Four-years of college currently cost $60,000 at a public university. In eighteen years, it may cost more than $145,000. To stay ahead of rising tuition costs, you should plan ahead and save early. Tax-favored 529 accounts can help you provide an excellent college education for your children and grandchildren.

Take for example one of our client’s grandchildren who I will call Joshua. As I’m writing this column it’s Joshua’s birthday. At age 11, he is well on his way to affording a college education – thanks to the help of his grandparents and his 529 plan.

Named for its section of the IRS code, 529 college savings plans first debuted in 1996 to promote college savings. In 2004, investments in 529 plans exceeded $54 billion. The NASD reports that one in eight families with children under 18 now own a 529 plan. Popular for their flexibility and tax savings benefits, 529 plans are ideal for any family saving for college.

529 plans are state-sponsored. Plans come in two flavors: college savings plans and prepaid tuition programs. All fifty states (and Washington, D.C.) offer at least one of the two plans. Many states offer both 529 prepaid tuition programs and 529 college savings plans. Whether you choose a prepaid track or a savings plan, all 529 plans are exempt from federal income tax.

Anyone can buy and benefit from a 529 plan. There is no income limit for account owners. Although plans vary by state, some accounts can be opened with as little as $5 or as much as $250,000.

Joshua’s grandparents opened the 529 college savings plan almost three years ago. Since then, the account has grown a whopping 76.6% averaging 22.5% per year. During that time, Joshua’s grandparents have enjoyed many tax benefits in addition to the reward of laying a financial foundation for their grandchild’s college education.

529 college savings accounts have great tax benefits. Investments grow tax-free. Withdrawals are also tax-free so long as they are for qualified higher education expenses. Required expenses can include tuition, fees, room, board, books, and supplies. Virginia and many other states even give you a state tax deduction for contributing to their 529 plan.

Joshua’s grandparents invested in Virginia’s CollegeAmerica 529 plan. As Virginia residents they received a $2,000 state tax deduction for their 529 contribution. For annual contributions exceeding $2,000, Virginia tax laws allow residents to carry forward the deduction to future years.

CollegeAmerica funds come in multiple share classes. A, B, and C shares are sold through salesmen as loaded shares with higher fees and expenses in order to pay the sales commissions. Needless to say, we don’t recommend these share classes. We use F-shares which are the no-load versions of the funds available through fee-only financial planners.

Each 529 savings plan offers different asset allocations in stocks, bonds, and cash to match the changing needs of the beneficiary. We designed Joshua’s portfolio which is currently invested in 10 different mutual funds. We adjust Joshua’s portfolio on a yearly basis. As Joshua approaches college age, his account is invested more conservatively to insure that the gains realized won’t be forfeited in a potential down market when they are needed.

The beneficiary of a 529 plan is also adaptable. Account beneficiaries are easily transferable among family members, including extended family. If Joshua does not go to college, the account can be transferred to one of his nine other siblings or cousins. Or, if money remains in the account after Joshua’s college years it can be transferred to his children. Even if the money is ultimately withdrawn for a non-educational expense, the penalty is small.

Parents and grandparents enjoy the measure of added control offered by 529 accounts. Unlike Coverdell Education Savings Accounts or UGMA/UTMA accounts which give control to the beneficiary, as owners of the 529 account, the investors retain control of their accounts.

Estate planning benefits make 529 plans the investment vehicle of choice. Accelerated gifting allows grandparents to contribute five years of tax-free gifting in one lump sum. These tax-free gifts up to $55,000 per person ($110,000 per couple) offer added long-term growth benefits.

529 plans have a limited impact on financial aid eligibility. For financial aid, 100% of the assets of the student are counted toward college funding. But if an account is owned by the parents, it is only assessed 5.6%. If held by a third party (e.g. the grandparent) the funds do not figure into financial aid eligibility calculations at all. Since Joshua’s grandparents own his 529 account, the funds won’t affect Joshua’s financial aid eligibility.

Joshua’s 529 account performed well above our expectation over the past three years. But, even modest gains of 8% combined with the tax benefits would have generated substantial savings for Joshua, his parents, and his grandparents. For more information about 529 college savings plans, visit www.savingforcollege.com . To avoid commissions find a fee-only financial planner in your area by visiting www.napfa.org .

Photo by Jacky Watt on Unsplash

---

1. College Savings Part 1 – A College Degree is Worth a Million Bucks
2. College Savings Part 2 – Start College Savings the Day They Are Born
3. College Savings Part 3 – Joshua and the Wall of College Savings
4. College Savings Part 4 – 529 Plans: What’s Important?
5. College Savings Part 5 – Prepaid Tuition Programs May Be Fool’s Gold
6. College Savings Part 6 – Tackling college costs at the eleventh hour