529 College Savings Plans

529 College Savings Plans

College Savings PigSeptember is College Savings Month. Therefore, today let’s focus on Section 529 College Savings Plans.  There are several good vehicles for this, but these get the most press. We will discuss others in the near future.

Section 529 of the Internal Revenue Code was enacted by Congress in 1996 to allow state sponsored savings accounts to help citizens save for higher education. It also allows for pre-paid costs in a particular state university system, but that is obviously not too attractive.

The big boost came in 2001 when Congress exempted all earnings from federal income tax when used for qualified education expenses. Now more than 11.5 million accounts are open with more than $227B invested. Why have they become popular?

First, they are easy to establish. Anyone with a social security number can open an account for the benefit of anyone with a social security number. So, parents, grandparents, mentors—anyone who can obtain the beneficiary’s SSN—can open an account. This person is also in complete control of the funds while living and can designate his or her successor in control.

Second, states allow an account to be opened with as little as $10. In Missouri, you can start a payroll direct deposit with $15 and otherwise, deposits can be $25 or more. The maximum is $325,000 for all accounts sponsored by Missouri for one beneficiary.

Missouri and Kansas also provide a state income tax deduction for deposits made in a particular year. Missouri’s is $8,000 for an individual and $16,000 for married filing jointly. Kansas allows $3,000 and $6,000 per individual or couple.

If you want to avoid federal gift taxes, you can deposit up to $70,000 the first year, or $140,000 for the married filing jointly couple. This is based upon a five year averaging of the $14,000 gift exclusion per person per year rule.

What about the investments? This is the weakness of all the plans, in my opinion. But first, what is good? The programs are simple. They provide a fairly small number of options. They can be age-based and automatically adjust with the time remaining for a child before college entrance. Others include specific mutual funds or blends emphasizing growth, income, or in between. Missouri uses Vanguard as its investment company while Kansas has its contract with our local American Century Investments.

The problem is the bureaucrats decided that no one should be able to manage his account well. Therefore, you may only make an investment change of any kind once per year. It matters not if world markets are melting down as happened twice in the past fourteen years. You may not protect your capital and re-enter when the bleeding has stopped unless the second change is in the next calendar year. Oh well, saving and investing for the need is better than not, even under this circumstance.

Extra credit: Suppose you are 50, very well heeled and taking advantage of all your other retirement tax-deferral loopholes. Put in $325,000 in an account for yourself as beneficiary. The state will let you deduct $8,000 in Missouri. It will grow tax free until you spend it or die. When you are 60-something, pick out a bastion of higher education that will take your money. Why not study Ecology of the Beachfront in Belize? You may not be able to spend several hundred thousand, but it would be fun trying. The rest you take out is penalized by state tax and an extra 10 percent federal, but the tax deferred growth should have made up for it.

(Past performance is no guarantee of future results. Advice is intended to be general in nature.)

 

September 17th, 2014|Categories: Personal Finances|