It’s an exciting time, but also a scary one…Your little, or not so little, one is checking out colleges. That’s exciting, but then you think…How am I going to pay for it?
529 plans are extremely effective for paying college expenses, however, BE AWARE there can be some pitfalls specifically with distributions and Financial Aid.
A 529 plan is an education savings plan used to pay the costs of qualified educational
institutions nationwide. Although contributions are not deductible, earnings in a 529 plan
grow federal tax-free and will not be taxed when the money is withdrawn to pay for
qualified educational expenses (including private K-12). Additionally, many states
currently offer residents a tax deduction or credit for 529 plan contributions. For
example, in SC you have an unlimited state tax deduction up to the maximum
contribution amount of $500,000. Even though 529 plans can differ from state to state, you can be an SC resident, invest in an OH plan, and send your student to college in NY.
*Choosing an out of state 529 plan may mean forfeiting any state tax advantage!
What about financial aid?
A 529 account owned by a parent for a dependent student is reported on the federal
financial aid application (FAFSA) as a parental asset which is assessed at a maximum
5.64% rate in determining the Expected Family Contribution (EFC). This is considerably
less than the 20% rate on non-529 assets owned by the student. A 529 account also has favorable treatment in the income portion of the financial aid eligibility formula. A distribution from the parent-owned 529 plan to pay college expenses will not be considered income.
This leads to the pitfall for grandparent-funded college 529 plans: A grandparent-owned plan is not reported as either a parent’s or a student’s asset, so it will not affect their eligibility for need-based financial aid; however, distributions from the grandparent-owned 529 plan technically is considered a gift to the student and treated
as untaxed income in the following year. This aspect of a 529 plan is far less
understood and could affect the student’s eligibility for financial aid.
What can we do?
A few solutions include:
Wait to withdraw money from the grandparent-owned 529 until after the financial aid form has been filed for the student’s sophomore year.
If your plan allows, switch the owner to the parent of the student or the student themselves (the latter can bring up a host of other issues and should be considered carefully).
If your plan does not allow this, transfer the plan to a state 529 that does allow switching. In the case of South Carolina and Georgia 529 plans, they do allow for changing the owner from a grandparent to the parent of the student.
Here is another possible pitfall because room and board expenses no longer appear on school bills. You can use the 529 plan funds for off-campus living, but only up to the amount the school charges for room and board. For example, if the off-campus living
expense is $12k and the school allows for $10k, you can only use $10k from the
Computer and internet services
You can pay for a computer and internet expenses; however, they must be used
primarily for the benefit of the student and here is a caution: watch out when the internet
bill comes bundled with other services.
Withdrawing too much money
If it’s within 60 days of the distribution you can roll it back into a 529 plan, provided you have not rolled over that child's 529 account within the prior 12 months.
After 60-days, but within the same calendar year, you can look to prepay next
year's expenses (if the school allows). After year-end, there's not much you can do about it. You need to pay tax and penalty. But remember it is on the earnings, not the contribution amount.
Please consult your financial, estate, and/or tax advisor regarding your personal
circumstances and to know if these strategies may be suitable for you. An investor should consider--before investing--whether the investor's or designated beneficiary's home state offers any state tax or other benefits that are only available for investments in such state's qualified tuition program.
Thomas M. Dowling CFA, CFP®, CIMA® is a Registered Representative and Investment Adviser Representative of and offers securities products and advisory services through Aegis Capital Corp Member FINRA/SIPC as well as SEC Registered Investment Adviser, As such, these services are intended for individuals residing in the states in which the advisor is licensed. Locally, he is a member of the Rotary and sits on the Board of Directors of the Hilton Head Baseball Association, Hilton Head Boys and Girls Club and the Town of Hilton Head Parks and Recreation Commission.