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529 Plans- The Basics - Pinnacle Investment Management, Inc.

529 Plans- The Basics

May 27, 2016 / Blog


May 29th (5/29) is National 529 College Savings Plan Day—so what better time than now to look at the ins and outs of 529 accounts and how they may fit into your educational savings plan.

When saving for college, there are many things that you need to keep in mind, from how financial aid will be impacted to what tax credits you may be able to use. And while there are many different ways to save for college, if properly used, a 529 account may be one of your best options to save for the college costs of your children, grandchildren, or even yourself.

Before looking at any college savings vehicle, the first step in saving for college is saving! The large costs of college are well publicized. According to the College Board, one year at the average four-year private college for 2015–16 costs in excess of $43,000. That cost includes published tuition and fees, room and board, and other expenses. Over the last 10 years, the cost of attending college has increased on average about 5% per year.

The earlier you can start saving for future college expenses the better. The more time you give yourself, the more time you have to let the power of compound interest and tax deferred growth work for you. Even if you aren’t able to save a lot, it’s a good idea to simply get the ball rolling. For instance, if you save $200/m for 18 years and the money grows by 6% per year, you should have a little over $77,000 by the time your child enters college. If you can increase that amount to $500/m then you should have about $193,000. While these amounts may not be able to pay for the full cost of college, it is a great starting point.

It is also important to note that for many, paying for college doesn’t come down to just what they have saved in 529 accounts. A well rounded college plan may include 529’s, financial aid, loans, and more.

In this first post of three, we will look at the basic mechanics of 529 plans. In the second post we will review their tax advantages, look at what expenses qualify for tax free 529 withdrawals, and discuss the potential penalties associated with non-qualified 529 withdrawals. In the third and final post we will review how 529’s impact financial aid and the role grandparents can play in saving for their grandchildren’s education.


What is a 529 Plan?

A 529 account (named 529 as it refers to the specific provision of the Internal Revenue Code) is a tax advantaged college savings plan sponsored by a state or educational institution. There are two types of 529 accounts: a savings plan and a prepaid plan. The most well known and the one we will discuss is the savings plan, which works much like a 401(k) or IRA, but is structured for college savings and not retirement. Every state, besides Wyoming, offers at least 1 college savings plan.

As 529 plans have grown in size and popularity, they have also grown in ease of use. Most 529 plans now allow you to open an account for a very small amount, and some even have no minimum contributions. The Connecticut 529 program can be opened for just $25. Many programs also allow for automatic payments through electronic transfer from your bank account or from payroll deduction. Like saving for retirement, automatic contributions can provide great discipline to the savings process.

The are several advantages to a 529 plan and below we list some of the most important:


Tax advantages: Money that you contribute to a 529 account will grow tax deferred. If you withdraw from the account for qualified education expenses, then the money is tax free. There are also potential state tax advantages. We discuss the tax advantages to 529 plans in more detail in our next post.


Availability: One of the best features of a 529 plan is that almost anyone can participate. While most tax incentives, like the Coverdell ESA or the American Opportunity Tax Credit, are phased out for higher income earners, there are no income restrictions to a 529 plan. There are also no restrictions on age, state, or the number of accounts you can have. 529 plans can also be used for most types of schools, including graduate and some trade schools. Savingforcollege.com has a great tool that allows you to see what institutions are 529 eligible.


Flexibility: 529 accounts offer a great deal of flexibility for the account owner. The account owner retains control of the account and has the ability to make changes.

While each 529 account must have a beneficiary, the account owner has the flexibility to change him or her. The only restriction to changing the beneficiary is that they must be considered a “member of the family” of the current beneficiary. Member of the family is a pretty broad category, and it includes relatives such as aunts, uncles and first cousins. The flexibility to change beneficiaries is a huge advantage with 529 accounts.  For example, if Mr. Smith lists his son Jack as the beneficiary of a 529 account, he can change the beneficiary to his daughter Elizabeth if, for some reason, Jack doesn’t need the money (i.e. decides against college or gets a full scholarship).


Investment Options: 529 accounts can be viewed almost like a state sponsored mutual fund. The money you contribute to the 529 plan is invested and the value of the 529 is determined by the performance of the chosen investment. While the tax law doesn’t allow you to personally direct the investments of the 529, you are given a good degree of flexibility in choosing which funds to utilize. Many 529 Plans offer age based investment options, similar to the ones seen in 401(k) plans. The idea behind those plans is to invest aggressively when the time horizon is longer and get more conservative as the child reaches college age. Plans also may offer more static options, like a 100% stock fund, 100% bond fund or a money market.


Sources & Further Reading
College Board- 2015 Trends in College Pricing
The Best Way to Save for College by Joseph Hurley


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About the author

John Shanley: CFP ® is a Financial Advisor with Pinnacle. He joined in 2015 after previously working as a Financial Consultant for Fidelity Investments. John is a Certified Financial Planner, a graduate of Fordham University and is currently pursuing his Masters degree in Financial Services. John is a native of Pawling NY and currently resides in Suffield with his wife, Jennifer, who is an Immigration Attorney. In his free time, John enjoys reading and is an avid hockey fan.

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