The latest version of a national study found that 70% of parents have begun saving for their child’s college education, although only 56% of these parents have a financial plan to meet their saving goals. On average, parents started saving for college when their child was five years old and have an average of $35,300 in a 529 college savings plan. 
What is the 529 College Savings Plan?
A 529 plan is a tax-advantaged account, meaning there is no federal income tax on investment gains, and qualified distributions (defined in IRS publication 970) are income tax-free. When used at an institution participating in the US Federal Student Aid program, eligible expenses include:
- Tuition and fees
- Books, supplies, and equipment
- Expenses for special needs services that are required to facilitate the student’s enrollment or attendance
- If the student is enrolled at least half time, room and board may also be a qualified expense.
529 plans come in two distinct types: investment-based or pre-paid tuition plans. Investment-based plans allow for a flexible contribution schedule over time, generate a market-based return on your investment, and offer the greatest amount of flexibility within the eligible expense guidelines above. These plans are generally appropriate for those comfortable with market-risk and a sufficient hold period.
Pre-paid plans, by contrast, usually come with a rigid contribution schedule. They allow investors to lock in the current cost of tuition by pre-purchasing a certain number of credit hours at a particular university or college system (if the student decides to go a different school, plans include a calculation for a cash payout option that can be used for any qualified educational expense). Prepaid plans are generally appropriate for those looking to avoid market risk.
Benefits of a 529 plan
First, “because 529 college savings plan assets are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of about 5.6%.”  That’s going to mean the beneficiary will be eligible for more aid than if they had a student asset.
Generally, the investors who will benefit most are in a relatively high tax rate with a relatively long holding period so that the tax benefits can compound over time. Contributions are considered “completed gifts” for estate tax purposes, and there is a provision within the tax code allowing them to gift up to 5 years worth of their annual giving limit into a 529 plan without eating into one’s lifetime gift-tax exclusion.
Limitations of a 529 plan
Among the primary limitations is that 529 distributions must be made within the same tax year that the expense is incurred. Also, tax-free distributions coordinate with other tax credits and scholarships. For example, if you receive a tax-free scholarship or tuition assistance, you may need to re-characterize your 529 distribution to become a taxable one; undermining the original incentive for opening a 529 plan.
The most well known limitation is the dreaded 10% penalty. So, if your child isn’t likely to attend college, a 529 may be too limiting for your family.
When should I start?
Like all savings plans, starting early, and contributing regularly are the best ways to ensure you meet your goals. Especially if you’re starting an account for a young child, it might be wise to include a Roth IRA and non-qualified accounts to diversify your savings, and avoid penalties, in case they decide college isn’t the route for them.
Please contact us to have a conversation about saving for your child’s college education.