Consider Investing Toward College for a Loved One with a 529 Plan

As college costs continue to climb, it may be time to consider saving for college. Explore the topic of 529 plans and how they fit into a financial plan.

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When you think of investment accounts, a higher education savings plan may not be the first thing that comes to mind. But if you want to help your child or another relative with their higher education needs, you might consider adding a 529 account to your financial plan.

This is especially true as the costs of higher education continue to rise. According to the College Board, published in-state tuition and fees at public four-year schools rose an average of 3.2% a year beyond inflation from 2007-2008 to 2017-2018.

Enter the 529 college savings plan. These investment accounts can help pay for higher education expenses such as tuition and fees, room and board, books, computers, and software related to eligible colleges, universities, vocational schools or other eligible post secondary educational institutions.

“It’s a potential, tax-advantaged way for people to start planning for college,” said Amy Motylewski, senior specialist for retirement and 529 products for TD Ameritrade.

529 Account Benefits

In addition to 529 account growth being federally tax deferred, qualified withdrawals are free from federal tax and generally not subject to state tax. Contributions aren’t deductible on your federal taxes, but some states offer benefits for in-state residents using the state 529 plan, usually in the form of making contributions tax-deductible, Motylewski said.

Compare that with withdrawals from a brokerage account, where you’ll likely have to pay capital gains taxes on any earnings.

Another key advantage of 529 accounts is that they can expand what you can give to a loved one without paying a gift tax, Motylewski said.

Normally, you can’t give someone, other than your spouse, more than $14,000 in a single year without paying a federal gift tax. A 529 plan is the only way to contribute as much as $70,000 in a single year without paying a federal gift tax (and up to $140,000 for married couples filing jointly). This is achieved by counting future gifts in the current year. For example, the $70,000 gift counts for $14,000 in the current year and four annual gifts of $14,000 in the future years.1

Another nifty feature of 529 accounts is that you can change the beneficiary within the family if you end up having extra in the fund.

Or, if Junior turns out to be a promising rocket scientist (or a star athlete), and happens to land a scholarship, you can withdraw money from the 529 plan, without penalty, up to the level of the scholarship. Your withdrawal will still be subject to taxes on earnings but you will not have to pay the 10% penalty for nonqualified withdrawals. 

A Balancing Act

Of course, you also have to think about your own future, which may mean saving for retirement. You'll have to balance that need versus wanting to save for your kid’s, or other loved one's, education.

“That’s an age-old problem,” Motylewski said. “It’s most important to be mindful of that problem.”

She said a lot of people don't think about the big picture and end up saving for one or the other, but they need to find a way to split those needs in a way that works for them.

An investor should consider a 529 plan’s investment objectives, risks, charges and expenses before investing.  A plan’s Program Disclosure Statement contains this and more information, should be read carefully before investing.

Investors should consider before investing whether their or their beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program and should consult their tax advisor, attorney and/or other advisor regarding their specific legal, investment or tax situation.

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This material is provided for general and educational purposes only, and is not intended to provide legal, tax or investment advice, or for use to avoid penalties that may be imposed under U.S. federal tax laws. This material is not an offer to sell or a solicitation of an offer to buy any securities. Any offer to sell units within a 529 Plan may only be made by the Program Disclosure Statement and Participation Agreement relating to the Plan.

TD Ameritrade does not provide tax advice. Every individual’s tax situation is different, and it is important to consult a qualified tax advisor regarding the application of a plan’s benefits to your own individual situation

1A donor may elect to treat a contribution to a beneficiary's account as made ratably over a five-year period. As a result a donor may make a contribution to a beneficiary's account of up to $70,000 for 2017, which increases to $75,000 as of January 1, 2018 (or up to twice that much if the donor and his or her spouse elect to “split” gifts) without any negative gift tax consequences, so long as the donor does not make any additional contributions to the account (or any other gifts to the account beneficiary) during that tax year or any of the succeeding four calendar years. A Federal Gift Tax Return (Form 709) is required to be filed. Please consult with your tax or legal professional. If the donor dies before the end of the five-year period, the portion of the contribution allocable to years after the donor's death will be includible in the donor's estate for Federal estate tax purposes.

Investments in 529 plans are not guaranteed or insured by the FDIC, SIPC or any other government agency, and are not deposits or other obligations of any depository institution.  

Withdrawals used to pay for qualified higher education expenses are typically free from federal income tax. These expenses include tuition, fees, books, computer equipment and software, supplies and equipment required for enrollment at a qualified institution of higher education. Room and board is considered a qualified education-related expense if the student is enrolled on at least a half-time basis. The earnings portion (if any) of a Non-Qualified Withdrawal will be treated as ordinary income to the recipient and may also be subject to an additional 10% federal tax penalty.

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