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When it comes to college savings and the conversations generated around this topic, there are three numbers that are reign supreme — 529.

The Name

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, also referred to as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.

Tax Characteristics

What makes a 529 College Savings Plan so unique? Let’s count the ways.

  1. Contributions made to the account qualify for a state income tax deduction (in some states).
  2. Contributions grow tax-free while invested within the 529 account.
  3. Contributions are tax-free at distribution when used for qualified educational expenses.

In the world of personal finance and investing, we call this type of account the “triple threat” because of the tax savings at contribution (in some states), during the lifetime of the account, and at distribution. There are very few accounts in the personal finance toolbelt that offer this type of preferential tax treatment.

Contrast the 529 with saving for college in a taxable investment account. Even without the state income tax deduction, each year the income and dividends produced by the account are taxed as income. And don’t forget about the capital gains tax assessed at distribution when positions are sold to cover college tuition. The combination of those two elements alone leave less purchasing power when compared to letting those dollars grow within the tax-efficient 529 environment.

Other Benefits

If the tax savings alone wasn’t enough to peak your interest, let’s talk about some of the other benefits of a 529 college savings plan. Already referenced, but worth mentioning again, dollars within a 529 can be invested in the market. Much like your retirement savings in a 401(k) plan, the funds in a 529 plan can also benefit from a long-term investment strategy.

From an estate planning perspective, a second and third added benefit is that the funds within a 529 are owned and directed by the account holder but are for the beneficiary of the minor. In other words, that future college student does not have control of the assets and cannot decided to buy a sports car with those dollars instead of a college education. The account holder has total control. While that account holder has total control, the 529 is not included in their taxable estate. This is another wonderful benefit of the 529 account, especially those with a potential taxable estate issue — perhaps grandma and grandpa?

The final benefit of a 529 is its flexibility, regarding he beneficiary of the account. As mentioned, each 529 account has an account holder and beneficiary. Over the life of the 529 account, the beneficiary can be amended and renamed, as needed. A common example is renaming the beneficiary from big sister to little brother after big sister graduated from college with funds leftover in the account. The dollars remaining can be reallocated to little brother to help fund his college expenses.

The Strategy

Are you thinking about opening and funding a 529 account for your future scholar? If so, a great place to start is to schedule time with a financial advisor to determine a target savings plan to help your child with college expenses. There is no one-size-fits-all savings strategy and it can be customized to cover two years of tuition all the way through graduate school.

Where to Start

The first step in the process is to set up the account and investment allocation and begin funding. Some numbers to keep in mind are the threshold for making a taxable gift of $15,000 per donor to donee and the maximum state income deduction amount, if applicable for your state.

Once those values have been identified and accounted for, it’s recommended to set up automatic monthly contributions to meet the target savings amount. Treat these contributions like the deferrals into an employer 401(k) and set-it and forget it.

There may never be a perfect time to discuss college savings options for your child, but the most important thing is that you have the conversation and start as early as possible.

Maureen D. Wright Maureen D. Wright Financial Advisor

Maureen has been involved in the financial services industry since 2013. She graduated summa cum laude from Illinois State University.

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