Flexible College Savings

529’s are the vehicle of choice for college savings. Your money grows tax free and distributions for college are tax free.

That’s great when things are straight forward. Most questions around these plans come from the land of “What if?” and that’s actually where 529’s may be a bit more forgiving than you think.

Most people know that there is a 10% penalty and income tax associated with withdrawals that aren’t used for college. However, what you may not know is that these taxes are only applied to the gains in the account. So, if you put $20,000 into a 529 and you cash out the whole thing when it’s worth $30,000 you only pay taxes and penalties on $10,000. With a 15% tax rate you’d pay $2500 in taxes which ends up being 12.5% on the whole distribution. So, it’s not as bad as it sounds.

There’s also another treatment that lessens the blow even more. It’s called pro-rata tax treatment. So say something comes up before college, and you don’t want to cash out the whole account, but you need to tap into it for some extra money. Any distributions of part of the account are taken out proportionally from gains and principal. In our example, if your account was worth $30,000 and you needed $10,000. You’d only pay tax and penalty on $3,333. The other $6,667 of that distribution would be a return of principle.

Furthermore, there are 3 main ways that the 10% penalty gets waived for a non-college distribution

  1. The beneficiary becomes disabled or dies
  2. The beneficiary receives a scholarship
  3. The beneficiary attends a military academy

 

More complicated allowances also exist if you receive tuition aid from an employer.

Another big deal about 529’s is that you can change beneficiaries any time, and the taxes are applied to the beneficiary, not the owner (who’s money it is).

Although these plans are predominantly for college, there is more to them than most realize.

As always, don’t hesitate to call us if you would like more information, or have been considering one of these for yourself of your family. 

*The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses. All indices are unmanaged and investors cannot invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results. The Dow Jones Industrial Average (DJ IA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.