April 2013: An Ode to the 529 Savings Plan

Ahh, spring is here.  The flowers, the birds.  Sunny seventy degree weather.  It's time to scrape the rust off the grill, test drive the lawn mower (or call the gardener!) and order some running shoes.  And, of course, I always find this burst of renewal a great time to reflect on financial goals.  After all, it still rains in the spring, so take advantage!

For those of you that have been diligently reading my quarterly letters (thanks Mom and Dad).  You will remember that there is Financial Spring Cleaning that needs to be done.  The rest of you can catch up on that here.  It's also a good time to revisit your goals.  One goal that I have discussed often is saving for college.  But not only saving for college, saving for college with the 529 plan...

An Ode to the 529 Savings Plan

(Or: How to save for college while sticking it to the tax man - legally!)

When you think about common financial goals, college ends up being a big one.  Actually, it's a doozy.  For most people, paying for their children's college will be the one of biggest expenditures they ever make.  Second only to their house.  But at least with your house you can take 30 years to pay it off.  College costs hit in a four year window (hopefully only four years)!

Given the size of the goal, I'm surprised that the 529 plan is not more popular. These are state sponsored accounts that are used to fund tuition for your child's college education.  They come in two varieties: pre-paid tuition and savings plans.  The pre-paid tuition plan allows you to buy in-state college credits for today's prices and use them in the future.  Unfortunately these can only be used for a college in your home state.  How do you know what school your child will go to?  Quinn can't even construct sentences of more than two words, how is she going to be able to tell me what college she prefers (I was playing the word game with her the other day and I got her to say "Berkeley")? 

Generally, in planning, I focus more on the College Savings 529, which allows you to save money  that can be used at any accredited institution in or out of state (and a large number of international locations).  But, a surprising number of people that I talk to seem hesitant to use this vehicle to save for college tuition.  Which is unfortunate, because there are some great advantages. 

Tax Benefits

"Don't try to understand the tax code", one of my instructors once informed me, "just memorize it."  Despite this rather tragic admonishment, I was also introduced to the concept of tax symmetry. Which sometimes, but not always, runs through the tax code.  The 401K is a great example of tax symmetry: you get a tax deduction now, when you contribute; but later when you withdraw, you owe taxes. No tax now, but tax later: symmetry.  The 529 Savings Plan is one of the few places in the tax code where you get better than symmetry in the tax code.  You contribute dollars today, the earnings grow tax free, and they are never taxed as long they are used for qualified college educational expenses.  I will repeat for the disbelievers: earnings are never taxed as long they are used for qualified college educational expenses!  Those are very rare words in the tax code.

In addition to the earnings benefit, here are some other advantages to the 529 Savings Plan:

High Contribution Limits: Unlike some other tax advantaged savings options, the limit for tax deferred contributions is set at the Gift Tax exclusion, which is $14,000 in 2013.  This is per person, per beneficiary.  So a couple could contribute $28,000 each year to a 529 plan for each child.

5 Year Accelerated Contribution: Contributors are allowed to front load their contribution and place 5 years of contributions in at once.  So each parent could contribute $70,000 to junior's 529 account.  They can't make another contribution until 5 years have elapsed.

State Tax Deduction: Some states allow a portion of the 529 contribution to be written off of state taxes.  Unfortunately California is not one of the states that gives a deduction.

There are some other "soft" benefits associated with the 529 plan.  For example, when family members ask what type of present they should get Quinn for her birthday, I suggest an item and a contribution to her college savings account.  I call this "The Grandparent Effect".  If relatives are really motivated, they can even open their own 529 for your child.  That way, they can also benefit from the state tax deduction if it is available.  Additionally, I find it helpful that the 529 plan keeps college funds separate and distinct.  I feel this helps people focus on the specific goal of funding college.

In closing

I think the 529 is an excellent tool to address the pressing need for parents to save for college.  I also think it is under appreciated.  This was just a quick overview of some of the main benefits.  If you'd like to talk about 529 plans and how they would fit your situation, I'd be happy to talk with you.  Also, if your friends or family have questions about 529 plans or any financial issue, please feel free to make an introduction or forward this letter.  We provide Financial Planning and Investment Management services and would be happy to talk with your acquaintances.  We will treat your friends and family with the same care and diligence that we treat you.
 
Thanks,

Brian McCann, CFP®