Here is an explanation of 529 plans to fund college educations taken from a well-respected college planning firm. Review this accurate treatment, then allow me to add my perspective:
Offered by states and some educational institutions, 529 plans let you save up to $14,000 per year for college costs without having to file an IRS gift tax return. A married couple can contribute up to $28,000 per year. (An individual or couple’s annual contribution to the plan cannot exceed the IRS yearly gift tax exclusion.) These plans commonly offer options to try and grow your college savings through equity investments. You can even participate in 529 plans offered by other states, which may be advantageous if your student wants to go to college in another part of the country.
While contributions to a 529 plan are not tax-deductible, 529 plan earnings are exempt from federal tax and generally exempt from state tax when withdrawn, as long as they are used to pay for qualified education expenses of the plan beneficiary. If your child doesn’t want to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from a 529 plan into another 529 plan established for the same beneficiary (or for another family member) without tax consequences.
In addition, grandparents can start a 529 plan, or other college savings vehicle, just as parents can; the earlier, the better. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself. Keep in mind, 529 plans are counted as available assets on the FAFSA [Free Application for Federal Student Aid] and can affect eligibility for student aid and loans.
Here are my observations about these plans:
Point 1: The more money you have in a 529 plan, the more it will diminish the chance of receiving any FAFSA funds that may otherwise be available. This is free money, or “aid” money. Most likely your student will not be eligible for student aid if you hvae a 529 savings plan. All 529 plans are required to be disclosed when applying for aid.
Point 2: Why not use the proposed 529 savings money to purchase a cash-rich-savings life insurance policy on yourself, so that when your child/grandchild decides to go to college they can use the money from there? There is no tax on this cash value build up, if structured correctly, and it’s not hard to set up. And if you die before the college money is needed, the death benefit will pay into your living trust a multiple of five to 10 times more than any money you could have saved in a 529 Plan. So you will have the same cash available plus no taxes due on growth, AND you will have the enhanced death benefit to pay for a lot more than just one college education — think two, three or four educations! This is a no brainer
Point 3: If your child/grandchild does not go to college, then if you have set up a cash-rich-savings life insurance policy instead of putting the money into a 529, you still have all the cash to redirect or you can just leave it inside of your living trust so upon your death it can bless other family members as you choose. This is also a no brainer.
Point 4: Why not have the options to pay for rent, food, or other necessities for your college student and not be “required” to pay for only tuition, as the 529 forces? There are many expenses outside tuition and books. And if your student gets a scholarship, then you won’t be able to use the money inside of the 529 plan anyway. Things change over time, but 529 plans are rigid.
Point 5: Although the explanation above notes that the 529 plan money can be used at colleges out of the state, most states do not allow the tax deferral you get on the 529 to be transferred, so this induces the student to attend school in their geographic location and may deter them from applying to a college across country. Rules vary, but why place your money into a restricted environment when it isn’t necessary?
Point 6: And what if your student wants to attend college outside the country? Unfortunately, the 529 plans don’t provide the tax deferral when a child goes out of the country.
Summary: I hope you can see nothing but limitation using a 529 plan to pay for a college education. They sound good and upon comparison can look good, but no one knows what will happen in the future so why even risk so much for such a little tax deferral benefit? This again is a no-brainer.
For more information about how to structure other college saving options, including a cash-rich-savings life insurance policy, contact me: firstname.lastname@example.org.