While a 529 plan account may the best vehicle for a your family’s College Fund, making the right choice means you’ll need to understand the basics. As you do your financial planning for college, keep these thoughts in mind:
- It’s not where your child goes to college, it’s where your family lives that matters: You can contribute money to any state’s 529 plan, regardless of where you live, and you can use the money from your account to send your student to any qualified college in any state. The state “brand” of your 529 plan is important for tax and estate planning reasons, but it does not limit your ability to make payment to the school of your choice.
- It’s not the student’s money: When you open a 529 plan account, you’re going to open the account in YOUR name (or your spouse’s name) because you are actually the account owner. This may come as a surprise, but your student is only the “beneficiary” of the account, meaning they can only access the account by going through you.
- This money can only be used for college: Distributions from 529 plan accounts for purposes other than Qualified Higher Education Expenses (QHEE) may result in taxes and penalties, so store only college money in the 529 plan, not money you may need for private K-12 education.
Now that you understand the basics, lets look at the steps you’ll need to take as you do your financial planning for college.
- Find out if your state offers a tax advantage for 529 plan contributions. Colorado, Georgia, Idaho, Iowa, Kansas, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia, West Virginia and Wisconsin offer state tax benefits for 529 contributions made by taxpayers in those states.
- Figure out how your state’s tax break works. Contact your tax specialist and ask these three questions:
- “How much money do I need to contribute to my state’s 529 plan to get the maximum tax benefit?”
- “How much will I save in taxes when I make my contribution?”
- “What’s the deadline for making a contribution?” Some states will only allow you to deduct calendar year contributions from your tax return while others will allow you to contribute up until the time your return s filed (as is the case with IRA contributions). If you discovered this article in March, this means you might still have a chance to save taxes if you forgot (or didn’t know) to make a contribution last year.
- Research investment results for both in-state and out-of-state plans. If your state offers a tax break for 529 plan contributions, it might seem like a no-brainer to sign up for your state’s plan. But what if your state’s plan is dogged by poor performance? The cost of lower returns may outweigh the benefit of the tax break, so do a little digging and run a quick calculation.
- Calculate the performance gap. That’s the difference in total return between your in-state plan and the out-of-state plan.
- Think about the amount of money you will have in the plan. If you’re targeting a four-year private university at a cost of $200,000 per student, and your family has nothing saved today, the average balance between now and then will probably be about $100,000.
- Calculate the opportunity cost of using the in-state plan by multiplying the performance gap by the average amount you’ll have invested, like this:(Amount Invested) x (Performance Gap) = Opportunity Cost)
- Let the opportunity cost help you choose your plan. If the tax benefit outweighs the opportunity cost, consider using your state’s plan. But if the opportunity cost is much larger than the tax benefit, the out-of-state plan might be a better choice. I say “might be” because there’s one more thing you need to consider as you choose your plan: asset protection. Some state plans confer a measure of protection against the claims of creditors, and in some states this protection only extends to physicians who live in that state and contribute to the in-state 529 plan. The law on this issue varies from state to state, so you might want to seek legal counsel if you’re at all concerned about the protections your plan may (or may not) afford.
Choosing the right 529 plan is not as easy as it should be, but these steps will help you make the right choice for your family.
Lawrence B. Keller, CFP®, CLU®, ChFC®, RHU®, LUTCF is the founder of Physician Financial Services. Based in New York, he offers income protection and wealth accumulation strategies for physicians nationwide. Contact him at (800) 481-6447 or LKeller@physicianfinancialservices.com.
W. Ben Utley, CFP®, is an attending advisor with Physician Family Financial Advisors, a fee-only financial planning firm helping physicians throughout the U.S. to make a plan and get on track with saving for college and invest for retirement.