Amy & Dan Smith's Planning for Life: Misconceptions about 529 Plans

Just like the kids you’re saving college funds for, 529 plans are often misunderstood. Read on to learn 529 plans are more flexible than you may think. They can be set up by anyone, for anyone, and used for a variety of education costs at all kinds of institutions, not just typical four-year colleges.

Myth: Only parents can establish a 529 account for a child
Reality: Anyone can open and contribute to an account for any beneficiary-no age limits or family connections necessary. Often, grandparents open 529 accounts to help fund college for grandchildren (with the added bonus that their assets won’t be factored into financial aid calculations and they may often benefit from reduced taxes on their estate).

Myth: Once the child is in college, he or she has control of the 529 account.
Reality: The account owner has-and maintains-control of the assets as long as the account exists.

Myth: Contributions to a 529 plan will limit financial aid opportunities.
Reality: While 529 assets can have an effect, it isn’t as significant as the impact of some other educational savings tools. Since 529 assets are under control of the account owner (not the beneficiary), they’re assessed at a maximum rate of 5.64 percent when determining expected family contribution (part of the financial aid formula). In comparison, investment assets in the student’s name, such as UTMA/UGMA accounts, are assessed at 20 percent.

Myth: I have to invest in the plan sponsored by the state where I live.
Reality: You can invest in any state’s 529 plan, but look at what your state’s plan offers first since some provide state tax breaks and other benefits to residents. Plans offered by other states may not provide these same benefits.

Myth: If I invest in a 529 plan, the beneficiary is limited to attending a public, four-year university.
Reality: Funds can be used for qualified expenses at eligible institutions in the U.S. and even some abroad, including private or public colleges, universities, and technical or vocational schools that qualify for federal financial aid. Check the department of education’s website (fafsa.ed.gov) and click School Code search to find qualifying institutions.

Myth: If it turns out the beneficiary doesn’t go to college or receives a scholarship, all the money I’ve invested is lost.
Reality: Since the owner – not the beneficiary- controls the account, you can change who receives the funds to any eligible family member. Another, although less attractive, option is to take a nonqualified withdrawal. Earnings are then subject to the usual taxes and a 10 percent penalty (penalty waived in the instance of a scholarship).

Myth: I can’t participate in a 529 plan because my income is too high.
Reality: Anyone can invest. There is actually no income limit to establish or contribute to a 529 plan.

Earnings in 529 plans are not subject to federal tax and in most case, state tax, so long as you use withdrawals for eligible college expenses, such as tuition, room and board. However, if you withdraw form a 529 plan and do not use it on an eligible college expenses, you generally will be subject to income tax and an additional 10 percent federal tax penalty on earnings. Changes in tax laws or regulations may occur at any time and could substantially impact your situation. You should discuss any tax or legal matters with the appropriate professional. 

From "Amy & Dan Smith's Planning for Life" column appearing monthly in the Blue Ridge Leader, Loudoun County, VA.

The foregoing article contains general legal information only and is not intended to convey legal advice.  For legal advice regarding estate planning, the reader should contact his/her lawyer.

Daniel D. Smith is a partner in the law firm of Smith & Pugh, PLC, 161 Fort Evans Road, NE, Suite 345, Leesburg, VA 20176. (Tel: 703-777-6084, www.smithpugh.com).

Amy V. Smith Wealth Management, LLC is an independent firm.  Amy V. Smith, CFP, CIMA offers securities through Raymond James Financial Services, Inc., member FINRA/SIPC.  Her office is located at 161 Fort Evans Road, NE, Suite 345, Leesburg, VA 20176.  (Tel: 703-669-5022, www.amysmithwealthmanagement.com). Any opinions are those of Amy and Dan Smith and not necessarily those of Raymond James.  Raymond James does not guarantee that the foregoing material is accurate or complete and does not provide legal advice.  Dan Smith is not affiliated with Raymond James.