• Wealth Management Division

September To-Do List

Let’s focus on college funding this month. Are your children or grandchildren growing at a fast pace, but you have not given their college plans more than a passing thought? Perhaps, a few thoughts by now? If that is the case, it is time to think about how you will pay for it and how a 529 plan may help you with college funding in general.

What is the 529 Plan?

A 529 college savings plan is a tax-advantaged account that allows investors to extend their college savings funds further. Saving a significant amount of money for college is a difficult task, but 529 plans have some powerful benefits that can assist you. To begin with, there are great tax advantages. Contributions (money placed into the account) are paid with after-tax dollars, but money invested in the account grows tax-free, and withdrawals (money taken out of the account) are tax-free as well when used for eligible educational expenses. Furthermore, several states provide tax breaks or credits for 529 plan contributions.

What kinds of 529 plans are there?

The two major types of 529 plans are college-savings programs and prepaid tuition plans. College-savings plans are the more popular and frequently superior option. They let you invest in stocks and bonds using pre-programmed investment portfolios. Many are available for purchase directly from the broker (direct-sold) and are typically suggested since they are less expensive. The rest are offered by financial advisers; advisor-sold plans often have a more hands-on approach and are focused on specific client’s objectives. However, such options can be more expensive since they are likely to include the cost of financial counseling.

Furthermore, there are two types of direct-sold and advisor-sold college-savings plans: age-based and static. Age-based plans are focused on the age of your child and as your child approaches college, the portfolio automatically moves from risky and higher-earning assets (stocks) to less-risky products (bonds). Such an approach protects your money from being wiped out in a case of an unexpected market downturn just before you have to pay your education expenses. You may also fine-tune your stock and bond exposure with certain age-based plans by selecting an aggressive (more equities) or cautious (less equity) route. Certain providers may allow you to select between an active and a passive portfolio.

In the case of a static plan, the investment portfolio remains the same, or static, throughout time, unless you actively modify it. A static portfolio allows you to create your own college savings portfolio by selecting components from a predetermined investment universe, which includes stock funds, bond funds, and balanced funds, which allocate to both equities and bonds.

On the other hand, prepaid 529 plans allow you to purchase public in-state college credits at today's prices, implying that you are not investing when you purchase them. Prepaid plans offer certain advantages, but they typically come with some conditions that make them undesirable.

What expenses are qualified for 529 plans?

Withdrawals from a 529 plan can be used to pay for college expenses, such as tuition, mandatory fees, books, computers, and software. If a student is enrolled at least half the time, room and board may be covered as well. You may also spend up to the amount specified by the college for housing expenditures. Furthermore, you can spend this much on room and board if your child lives off-campus.

What happens if I withdraw funds from a 529 plan for other reasons?

It might cost you a lot of money if you withdraw money for reasons other than qualifying expenses. Here are a few things you should be aware of:

  • Withdrawals for non-qualified expenses are generally subject to a 10% penalty.

  • Because 529 contributions are made with after-tax money, you will owe relevant federal income taxes on profits but not contributions. (Withdrawals from 529 plans are only allowed on a pro-rata basis, which means they cannot be made totally from contributions. For example, if you have $10,000 in contributions and $10,000 in profits in your 529 account, removing $5,000 takes $2,500 from contributions and $2,500 from earnings.)

  • You may also be required to return any state income tax benefits you obtained on your contributions.

What if my child does not attend college or does not use all of the funds?

In most states, 529 funds can be used for additional educational purposes such as trade school, graduate school, and K-12 private schooling. In addition, you can change the beneficiary of the 529 account, without incurring any tax implications.

Although, the new beneficiary must be related to the previous beneficiary’s family (rules on who constitutes a family member are very broad and include parents, siblings, some in-laws, first cousins, and stepsiblings). The funds must be used for eligible educational costs by the new recipient as well.

The material on this page reflects PG Capital's professional opinions as of today and is subject to change. The information presented here has not taken into account any particular investor's investing goals or needs, and investors should not base their investment decisions entirely on this material. Past performance is not a guarantee of future results. All investments involve some amount of risk, and investors have different time horizons, goals, and risk tolerances, so consult with your PG Capital Financial Advisor before proceeding.

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