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Posted on August 5, 2019

3 Money-Smart Strategies for 529 College Savings Plans

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Between squeaky new shoes, fresh pencils, packs of index cards, trendy new backpacks and other learning supplies, back-to-school shopping in the U.S. is expected to exceed $27 billion this year – about $510 per household. That’s a lot of Trapper Keepers.

But what about what we’re saving?

This time of year brings the topic of 529 college savings plans back to the top of minds of students, parents, grandparents and advisors across the country. These tax-advantaged plans are easy to set up and cheap to participate in. Contributions can reduce your state tax footprint and the money can then be withdrawn tax-free to pay for qualified expenses (tuition, books, etc.).

In other words, the benefits of having one stretch beyond simply squirreling away a little extra money for college.

Advisors often use this time of year as a reminder that we should start a 529, but what if you already have one? Let’s look at a few strategies for those dutiful parents and grandparents who already set up a plan.

Financial Aid Strategies for Student

Many of us may have memories of a sheaf of pink-and-white documents we (and our parents) slaved over with a pencil and hoped our math was right. Today, of course, the FAFSA® (Free Application for Federal Student Aid) is done online and in about half the time.

The FAFSA®  will want to know all of your personal and parental assets to asses how much financial aid they’ll give, and a 529 plan will affect financial aid, but it’s not as straightforward as it might seem. The amount of aid you’re eligible to receive depends on who owns the plan itself (not the beneficiary).

Let’s look at how this would work with a $50,000 plan:

Financial Aid Reduction Based on Plan Owner for a $50,000 529 Plan

Owner Reduction in Financial Aid
Student 20% ($10,000)
Parent 5.64% ($2,280)
Grandparent 0% ($0)

That last row is where you see a big difference with a small change. Grandma and Grandpa and great uncle Larry can have a $400,000 529 plan set aside for the student and it won’t affect financial aid in the slightest. The FAFSA only cares about the assets of parents and students.

When it comes to distribution, you have three options:

  1. Cash the plan out all at once and pay off as much as you can upfront without loans.
  2. Take a yearly distribution to reduce costs.
  3. Hold off and take a lump sum to pay for your final year so you can finish school on good footing.

Notice one option that’s not there: using your 529 to pay off student loans. That’s a no-no.

Tax-Smart Strategies for Mom and Dad

The 529 plan offers great advantages for you parents, especially – as with all financial vehicles – if you start early and think strategically.

The obvious analogy here is between a 529 plan and a 401(k) or an HSA. The tax benefits work similar to the Roth model – you make contributions with after-tax dollars, so withdrawals and growth aren’t taxed when the time comes.

Several states also offer a state income tax deduction for contributions. Contributions aren’t deductible on the federal level, but states vary and can be especially helpful if you use your own state’s 529 plan. Make a careful choice regarding which plan you’ll use upfront. Getting the best advantages (tax or otherwise) is a matter of shopping around – they aren’t all the same.

Great uncle Larry and other contributors may also qualify for a state income tax benefit no matter who owns the account. If the account is under the grandparents’ name so it won’t count against financial aid, you can still make contributions and get tax benefits, depending on the structure of the plan and the stipulations of the state you live in.

Remember also that you can keep contributing even when your child is in school. Funneling tuition payments and other expenses through the 529 plan can give you the state tax break on contributions the whole time your student is in school.

Superfunding for Grandpa and Grandma

Parents, grandparents and great uncle Larry can also participate in what’s called “superfunding.” In this scenario, someone can contribute five years’ worth of contributions in one large sum without going over the annual gift tax exclusion.

The math is simple. In 2019, the annual gift tax exclusion is $15,000. However, if you have the means to do five years at once right upfront – a superfunding of $75,000 – the growth is based on that sum. So instead of adding $15,000 one year, $30,000 the next and so on, your student will have $75,000 growing from year one.

The other side of this strategy to keep in mind is that the FAFSA® for future years is based on the student’s assets from tax returns from two years before. It may be to your advantage to wait until the last two years of college to superfund so future financial aid isn’t affected. Plan strategically.

Granted, this isn’t an option for everyone, but it is most often used by grandparents – just make sure you’re not upsetting the balance of your own financial goals and retirement.

First Step Savings, Next Step Strategy

College isn’t getting cheaper by any measure, and the days of students working as a janitor or a server to cover tuition are long past. In the year 2036, a public university education will cost nearly $180,000 and a private university will be around $303,000. The 529 college savings plan offers you a way to address this looming question early on in a child’s life.

Your family’s financial life needs an intentional strategy to grow and to avoid unnecessary expense. First step savings, next step strategy.

Want to talk about optimizing your 529? Contact us today.