Five Myths About Your 529 College Savings Plan
May 21, 2014As the school year winds down and the invitations to high school graduations start pouring in, I can’t help but think about the day when my own little girl Rachel—who is finishing up her sophomore year—will be sending out her own invitations. It all seems to be going by so fast but fortunately Susan and I have been preparing for that day by saving in a 529 college savings account. For some of you moms and dads out there, you too have been using this savings vehicle to help pay for those oncoming college expenses but as Kathryn Flynn writes in a recent post called “Clearing up the confusion: Five popular 529 plan myths,” there are a number of myths floating around out there that could cause confusion when it comes time to using these accounts. Understanding each one will help you and I when it comes time to funding our child’s higher education.
Myth #1: Money in a student’s 529 account will not affect financial aid eligibility.
Although 529 assets are included in the calculation for financial aid, the good news is that an account owned by the parent is considered a parental asset so its impact would not be as great as it could have been if it were the child’s asset. That said, some advisors (including yours truly) have suggested allowing non-parents to own the account. While that may prevent the assets from being counted, notice that distributions are treated as untaxed income to the beneficiary. For that reason, Ms. Flynn suggests non-parents wait until your child’s senior year to pay for the education.
Myth #2: A child has legal rights to money in a 529 account.
Unlike a custodial account where the child is the rightful owner and has a legal right to control the assets upon reaching the age of majority, a 529 account is the property of the owner, which is typically the parent. Owners have discretion over if and when assets are distributed, may roll over assets from one plan to another, and may change beneficiaries as long as the subsequent beneficiary is related to the original beneficiary.
Myth #3: I am required to use my own state’s 529 plan, and the funds must be used toward a college in my own state.
This is a common myth that I often hear in workshops but the simple truth is that you may use a 529 college savings (but not necessarily prepaid) account from any state and your child may attend college in any state and still receive the federal tax benefits. However, some states offer state income tax benefits to residents who use the program from their own state. Even better, residents of states such as Arizona, Kansas, Maine and Pennsylvania are eligible for state income tax benefits regardless of which state’s plan they use. Now how’s that for spreading the love?
Myth #4: 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.
Obviously the reason we put money into the 529 account is because we hope to use it to pay for qualified higher education expenses, but if we don’t, only the earnings will be subject to income taxes and a 10% penalty. If possible, rename the beneficiary to someone that will likely use the funds for qualified expenses. You might even name the child of the child that did not go to college (that would be your grandchild, by the way).
Myth #5: I will have to pay a penalty tax if my child is awarded a full ride.
If your child is fortunate enough to receive a scholarship, you may be eligible to withdraw up to the scholarship amount without penalty. Just remember that if the scholarship is tax-free the amount withdrawn from the account that is attributed to earnings may be taxed as ordinary income.
For those of you that may be planning to withdraw funds from a 529 account later this year, check out Joseph Hurley’s article on 529 withdrawal traps to avoid. If you’d like to learn more about using a 529 plan to help save for future college expenses, check out http://www.savingforcollege.com/ and http://www.irs.gov/uac/529-Plans:-Questions-and-Answers.