529 Savings plans are popular as evidenced by an average account balance of $17,174 and total plan assets closing in on $200 billion. Their appeal is due to high contribution limits, tax-free-growth and withdrawal (must meet federal requirements). Grandparents needing to gift money can contribute up to $14,000 a year without triggering gift taxes, and even make five years worth of contributions to move money out of their estate into to fund the grandchildren’s college.
While these benefits look good on the surface, I don’t often recommend them for a several reasons. First, 529 plan assets can reduce your child’s financial aid benefit because money in their account will count up to 5.54% of the student’s savings on the financial aid worksheets used by colleges and universities. The assets are treated as an asset of the parents, regardless of whether they are owned by the parent or a child. If a 529 plan is owned by a grandparent, most financial aid offices will include this as student income, even when the distributions are not reportable for federal income taxes.
Second, the investment choices are limited to state sponsored plans. When looking at investment options and performance of these plans compared with other options, the tax-free growth appeal looses its luster. Third, the funds can only be used for qualified higher education expenses including tuition, room and board, books, supplies and equipment.
A Simple Alternative
Given the average price tag for a public university degree currently sits at $37,800 and rising, you may find a smarter alternative within the 4 million words of the Internal Revenue Code. Section 2503(e) provides that gifts made to an education provider, on behalf of children, grandchildren or any beneficiary, don’t count as taxable gifts. Rather than funding a 529 plan, you could pay the child or grandchild’s tuition directly. You avoid gift taxes, aren’t limited with investment options, and the money is NOT counted against the student’s need for financial aid by the university’s endowment fund.
Often, the best plans are simple. So when considering education funding options, remember the time tested acronym K.I.S.S.
Andrew M. Brown, CFP® Certified Financial PlannerTM Fee-Only Registered Investment Advisor
Sources: http://money.cnn.com/2013/03/12/pf/college/college-savings/index.html
http://www.savingforcollege.com/tutorial101/the_real_cost_of_higher_education.php