Advanced Planning with 529 Plans

With the month of August, we get the year’s hottest temperatures, hurricane warnings, and the start of a new school year. This month’s newsletter will focus on the latter, specifically, the intricacies concerning educational savings for K-12 and secondary education. We have previously addressed the basics of 529 plans, which can be read here. This month’s newsletter will provide a more in-depth look at 529 plan features. Let’s briefly review some 529 plan basics. For starters, 529 plans are funded with after tax dollars and as long as the funds stay in the account, any investment gains or income achieved, will not be taxed. When the funds are removed from the 529 plan, so long as the funds are used toward qualified educational expenses, the investment gains and income removed from the account are not taxed. If funds are withdrawn from the 529 plan and not used toward qualified educational expenses, only the gains are taxed. There are no additional plan withdrawal penalties. In addition, people that contribute to a 529 plan in Louisiana, can use the contributions as an income reduction towards their Louisiana state income taxes. More can be read about the tax benefits, here. Besides the tax benefits, the Louisiana 529 plan also offers an Earnings Enhancement. The state of Louisiana will match a portion of the contributions made to a 529 plan account. The percentage of the contribution that is matched varies, based upon a few items: The relationship of the account owner to the beneficiary and the income level of the account owner. More can be read about the Earning Enhancement and how much you could expect to receive, here. Another key benefit of 529 plans that is often overlooked is the amount of control the account owner has over the funds. The owner of a 529 plan never loses control of the plan so long as it remains open or until they relinquish control. Meaning, the owner has full control of the funds and how they are disbursed for the entire duration of the account. What flexibility do account owners have once funds have been contributed to a 529 plan? 529 plan account funds can be transferred to other 529 plan accounts, so long as the beneficiaries of the two accounts involved in the transfer are related. In addition, 529 plan owners can change the actual beneficiary of an account they own, so long as the new beneficiary is a family member of the former beneficiary. One negative to 529 plans, is that there is a maximum account balance, which is five times the annual Qualified Higher Education Expense at the highest cost university in the state in which the account is opened. The account balance can GROW past this balance limit, but funds cannot be CONTRIBUTED once this limit has been reached. In the state of Louisiana, this balance limit is based upon the total value of all the 529 plans registered to the same beneficiary. For Louisiana residents in 2019, the max allowable balance for the College fund 529 is $500,000. For the K12 fund, this amount is $180,000. Recently, Congress has passed new regulation that allows for 529 plan funds to be used for grades K-12. The Louisiana state provided 529 program known as LA START calls this their K12 program. The K12 program operates nearly identical to the college program except for a few conditions: The K12 program does not provide state tax deductions to contributors and does not offer the earnings enhancement on contributed funds. Unused funds in the K12 program can be transferred to the College fund account, but College fund money cannot be transferred to the K12 account. If K12 funds are transferred to the College fund account, the transfer amount can be counted towards the earnings enhancement and the reduction of your state income taxes. In most cases, prospective owners of 529 plans would be better off saving and investing their 529 plan funds for college before contributing funds to a K12 account. We believe this because contributions to the K12 plan will not have enough time to grow significantly to really benefit from the tax advantages provided to the College fund plan. For example, opening an account when a beneficiary is born and then using those funds four years later for kindergarten may not provide you the significant tax benefits of these accounts. We are often asked what 529 plan do we recommend? For Louisiana residents, we typically recommend the LA START program over any other 529 plan. The fees for the LA START program are minimal. The only fees associated with the plan are the fund expenses built into the funds they offer, which varies between 0.0%-0.10%. For non-Louisiana residents, I would research your resident state and see what kind of programs are offered by your state. Ultimately, like any other investment account, be aware of the potential fees. Just because 529 plans are for education doesn’t mean all plans will have low costs. Some plans will charge similar fees that an investor may find with a mutual fund family. Depending on the firm, these fees can entail large up-front commissions that charge as much as 5% and annual fund expenses that exceed 1%. On the flip side, there are firms like Charles Schwab who offer low cost 529 plan options. The fees for the Schwab account range from .25% to 1.0% on annual basis. More can be read about Schwab’s plans, here. 529 plans can be very powerful savings vehicles, if used correctly. Upon further review, they provide a lot more benefit than simply saving for college. Please let us know if you have any questions.