The Ins and Outs of College Savings Plans


I have a friend with a new son, 16 weeks old. He asked me about 529 accounts, better known as college savings plans.

My friend has it spot on. Starting early with these plans is the way to go, allowing the power of compound interest to work its magic. Then, there is a wonderful  double-dip at the end, those earnings from compound returns incur no state or federal income tax liability. It’s joyous…

College savings plans were originally established the by the states, starting off in Michigan. Congress eventually got on board, and through a series of legislative  acts in the 1990s to early 2000s, we can now all enjoy the benefits of these plans for our kids, our grandkids, our nephews and nieces.

Here are the basics:

College savings plans act somewhat like a Roth IRA. Contributions are after-tax, but earnings are entirely tax-free and penalty-free if used for qualified education expenses.

Anyone can contribute to a college savings plan. Contributions are generally limited to $14,000 a year per person, the maximum allowable gift that is exempt from filing a federal gift-tax  return. Parents and grandparents can front-load 529 plans with five-years worth of contributions, or $70,000 per person, per beneficiary.

The plans are administered by the states. You can open a college savings plan in any state, regardless of where you live or plan on the beneficiary attending college. (This is unlike another form of 529 account, a pre-paid tuition plan.)

Some state plans are better than others. By better, I mean some states have lower management expense and  more generous investment options. Many states also allow for a state income tax deduction on a portion of contributions.

Over the years, some of best plans have been  administered by Utah, Iowa and New York. Georgia also has a terrific plan, and residents can claim a tax deduction up to $2,000 a year per beneficiary for single filers and up to $4,000 a year per beneficiary for joint filers.

The plans are set up in the name of the parent, or grandparent, as the account owner. The child is the named beneficiary.  This has a nice by-product, as the plans are not counted as an asset of the child, carrying a much smaller weight when applying for financial aid.

The beneficiary can be easily changed to another family member, or even yourself, depending upon how the future might unfold. And, in the event that your child gets a full or partial scholarship, the amount equal to the scholarship can be withdrawn without penalty.

As an example, let’s say my friend opens a college savings plan for his son. Though doing well, he and the boy’s mother  are young and have limited amounts of money. So, they are able to scrape together and  contribute $5,000 each, and get the grandmother to kick in another $5,000. That’s a total of $15,000. Let’s also plan on them doing this for the next 18 years, and earning an average 7% return a year. Their overall $270,000 of contributions will have grown to some $545,685. With $275,685 of earnings completely tax free.

Sound like the boy can go to college?

Though it may seem so, these plans are not complete honey and roses. Like all federal tax law, there is devil in the details. There are some hoops, some gotchas and some look-out below to be aware of.

Distributions used for other than qualified education expenses will be subject to a 10% penalty and ordinary income tax. The IRS allows only two exchanges or reallocation of assets per year. And, starting late is not useful. Without time on your side, earnings are not likely to grow enough to make the plans worthwhile. For some families and situations, it might make more sense to pay college tuition directly as direct tuition payments are not subject to the annual gift limitation.

And, let’s not forget that there are no federal loans for retirement. At least not yet. My friend and his wife need to save for retirement before saving for thier son’s college.

If you’d like to learn more, contact me or any of my fellow fee-only Certified Financial Planner ™ Professionals.



My name is Mike Sena and I am a fee-only Certified financial Planner (tm), a registered investment advisor in the state of Georgia and senior planner for Supporting Your Choices, Inc., a wealth management practice registered in Georgia, Florida and Texas. I am a loving father, speaker, author, radio personality and polo player. I'm happy in my life and definitely not your ordinary investment advisor.

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