Common Myths About 529 Plans

April 22, 2014

For my grandson’s upcoming first birthday, I mentioned to my daughter-in-law that we might invest in a Pennsylvania 529 college savings plan as our gift. She was a bit concerned since my stepson and his family are Maryland residents, not Pennsylvanians, and would that mean that he’d have to go to a PA school? The reality is that the 529 funds can be used at any college across the country and even accredited schools abroad so her fear was unfounded. My grandson will have the ability to use the money for any college of his choosing and by opening the PA 529 plan, we get the benefit of up to a $14,000 state income tax deduction and the advantage of Vanguard investment options.

My daughter-in-law is not alone in her confusion about college savings plans.  According to www.savingforcollege.com, there are 4 more common myths that parents have:

1) Money in a student’s 529 account will not affect financial aid eligibility.  However, 529 funds CAN impact financial aid because accounts opened with a parent as the trustee are considered parental assets on the FAFSA form and count up to 5.64% towards the EFC (Expected Family Contribution) against financial aid. But if a grandparent or other relative owns a 529 account, the assets will have NO effect on financial aid until a withdrawal is made and then the distribution would count as student income.

2) A child has legal rights to money in a 529 account. The truth is the owner of a 529 account retains control of the assets regardless of the age of the beneficiary.

3) If my child doesn’t go to college, or I use the money for something else, I’ll get hit with a penalty tax on everything I’ve saved.   The reality is that if you end up using the funds in a 529 account for something other than qualified educational expenses, only the earnings portion would incur the 10% penalty tax and you would owe federal and state income tax on those earnings. An exception to this penalty can be claimed if the beneficiary has died or is disabled, or attends a U.S. military academy. You can also transfer the value of the 529 plan to another beneficiary who could use it for their college costs.

4) I will have to pay a penalty tax if my child is awarded a full ride.  In fact, there is an exception for this, and distributions up to the amount of the tax-free scholarship will not be subject to the 10% penalty tax, although the earnings portion would still be subject to income tax.

So as a parent or grandparent, don’t shy away from a 529 plan.  Check to see if your state offers a tax incentive in addition to the federal tax-free growth. Most importantly, start saving early!