Flexible College Plan - The State Run 529

Of all the investments out there available to be made, the 529 is neither best or second-best, but it is right up there near the top.



Back when I was actively working in the financial planning business, it was one of the easiest to sell, as well. It holds one of the best sets of tax advantages, and is surprisingly flexible for something designed to fund a college education.



The State-run 529 works in relation to the IRS's gifting rules, and is subject to those and other limitations. There is a limit, that varies from year to year, on the maximum total contributions. However, it has a couple of powerful benefits that most investments do not have.



First off, you can front load it with up to five years worth of gifting contributions. With this currently at $11,000 per year, this means that an individual can give up to $55,000 and a married couple up to $110,000 all at once tax free.



Second, any investment income earned by the 529 is tax deferred until you take it out. So you're earning interest on any money you might otherwise have paid as taxes until you actually make a withdrawal.



Third, you, the donor, retain control over the investment, and can transfer it to another donee if your initial pick decides to skip college or wants to buy a motorcycle with the money. This contrasts with most college accounts, such as the Coverdell, that money is theirs, totally and irrevocably, on their 18th birthday, and they can sue you if you don't want them to buy a motorcycle with it. The 529 is the only account I'm aware of with this reservation. You can even recapture it for yourself in many circumstances, if you decide to. Nor is the money committed to any given learning institution (or group of institutions, and earning little to no income if the prospective client decides to go elsewhere, or skip college altogether.



With estate tax gone, the fact that investments in a 529 are no longer part of your estate is less important, but 529s pass with full tax deferral, immediately and outside of probate to named successor owners or beneficiaries, as applicable, and they have the option to keep them going rather than taking the money. Most other investments do not afford anyone else except a spouse this opportunity to keep the account going as it was.



Finally, if you use the money for college or college related expenses, the withdrawals are tax free. Even if you don't, the penalty is only ten percent of earnings, which is much smaller than, for instance, the Traditional IRA. Other neat facts adding to the flexibility: No matter where you live, you may use any state's 529 program, and go to college anywhere in any state you like, and still enjoy the full benefits.



To really illustrate how flexible this is, let us consider, hypothetically, the case of a 60 year old with a 40 year old child. Not too many 40 year olds go to school, but the 529 can be useful even so. Suppose the 60 year old has $50,000 they don't think they'll ever need, and they want to make certain the 40 year old gets it when they die, but wants to keep control of the money in the meantime, and wants a lot of bang for their buck. Consider the hypothetical of a 9% yearly return, every year. The 9% return is likely to be slightly low on the average, and the stock market never returns a consistent figure from year to year, but let us consider it. Suppose the parent lives 20 years. That $50,000 has turned into $280,000, same as a traditional IRA. But now the child has the option of keeping it going, which they do not have if it's in a traditional IRA, and they only have to pay tax on $230,000 if they withdraw it all at once. Put into a taxable account, even if it earned the same 9%, and assuming a 28 percent tax rate, it would only be $175,500. Assuming the same 28% tax rate, even withdrawing all of it at once leaves them with $215,600 - a $40,000 difference just for putting the money in a better account. Or the beneficiary can withdraw it a little bit at a time, to pay for, say, their own grandchild's college, during which time the remainder continues to earn income tax deferred.



There are limits as to how far Congress and the IRS will allow it to be stretched. Consult a financial planner in your area. But if you want tax deferrred, possibly tax free market returns and a lot of flexibility, most people choose investments significantly worse.



Caveat Emptor.