The faster you can start planning for the cost of education, the better. Opening a college saving account is a smart way to invest in the education of a family member, friend, or even yourself and it comes with tax benefits. One of the most popular options is a 529 plan. Below are some of the benefits and drawbacks…
Benefits are based on using distributions for qualified education expenses in Illinois. Tax benefits can vary by state.
Tax Free Growth
One of the most notable benefits of 529 plans is tax free growth. Hypothetically, if you invested $10,000 and it grows to $50,000, you will not owe taxes on the gains.
Tax Deduction
In Illinois, taxpayers’ contributions to 529 plans are tax deductible. Contributions are deductible up to $10,000 per year ($20,000 if married filing jointly). For example, if you owe $10,000 in state taxes and make a $10,000 contribution, you will save $495 in Illinois state taxes.
Not all states offer a tax deduction, so make sure to check with your financial professional to review your options.
Growth
With a 529 plan you have a variety of investment options. Your investments have the potential to grow and vastly outperform saving in a bank account. The average 10-year annual return in the stock market is 10% going back to 1926.
Control
As the owner, you can make sure the money will be used for its intended purpose. This is different from custodial accounts such as UGMA/UTMA, where the child has control of the account once reaching the age of majority (21 in Illinois)
The named beneficiary has no legal rights to the funds in a 529 account. The beneficiary can be changed to a family member at any time.
K-12 / Trade School Costs
529 plans are generally associated with college education, but that is not the only eligible expense.
They can be used for private primary and secondary schools. So, if you’re paying tuition for grades K-12, you can take advantage of a 529 plan.
Other qualified costs include trade schools, vocational programs, and registered apprenticeship programs.
Flexibility
Federal tax law allows the account holder to change investments twice a year or when there’s a change in beneficiary. That means if you don’t like your plan’s performance, you aren’t stuck with your initial selection.
Another benefit is the ability to change periodic contributions. The provider we use, Bright Directions, has an online portal where users can adjust their monthly contribution, make a lump sum contribution, and accept gift contributions.
Drawbacks
As with any investment, there are risks to using a 529 plan to save for college. Here are some of the pitfalls to look out for:
Limited Investment Options
A 529 plan owner must select from a menu of investment options offered by the state sponsored plan.
Penalty for non-qualified withdrawals
Non-qualified distributions are subject to income tax and a 10% penalty on the earnings portion of the distribution. However, there are expectations to the penalty if the beneficiary gets a scholarship, attends a U.S. Military Academy, dies, or becomes disabled.
Fees
Just like any investment vehicle, there are fees associated with 529 plans. Funds have internal expense fees and different fees by share class. It is important to review the fees associated with your investment selection.
Bottom Line
529 plans are a great way to start saving for education costs. Make sure to review your investment options to maximize your potential returns and minimize your costs.
If you have any questions or would like to open a 529 plan, please don’t hesitate to reach out.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimer and Sources:
Average Annual Return 10% from Investopedia
Stock market annual returns 1926-2021 data from Dimensional Advisors
Bright Direction Information from Bright Directions
529 FAQS from Bright Directions
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy ensures success or protects against loss. This information is not intended to be a substitute for specific individualized tax advice. The Standard & Poor’s Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Prior to investing in 529 Plan investors should consider whether the investor’s or designated 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. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
