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Thursday, March 7, 2013

Planning for Children's Higher Education: Is a 529 Right For Us?


As a parent to three daughters I can say from experience that the time goes by in a flash.  With one daughter in college and two on the way, my husband and I have been saving up for these expensive college years ever since we had our first child over 20 years ago.  Planning for college, saving for retirement, and learning to invest takes a good deal of time.  So here's a little guide based on actual questions I had for Richard Wald from Merrill Lynch.  I had a unique opportunity to pose my questions to an expert and you can benefit from his answers below.

First, a little about Richard.  Richard began his career with Merrill Lynch in 1986. As a founding member of The 712 Investment Group, Richard heads the team's West Coast operation and focuses on assisting high-net-worth clients with retirement and wealth management strategies. Richard holds the Chartered Retirement Planning CounselorSM (CRPC(r)) designation. He was recognized by Barron's as one of the Top 1,000 Financial Advisors in 2009, 2010, and 2013. Richard received dual Bachelor's degrees in Marketing Management and Broadcast Journalism from the Newhouse School at Syracuse University. He and his wife, Jillian, live in Alamo, California, and have two daughters. Before joining Merrill he was a marketing analyst and associate producer for ABC News.

Interview Questions:

How much will college cost when my child is ready to attend one of the following:
  • State college
  • State university
  • Private college

According to College Board 2013 estimates, annual total charges for tuition, room and board, and fees at a U.S. public institution average $17,860 for in-state college, amounting to $71,440 for four years. At a U.S. private college, the average annual cost is $39,520, yielding a total cost of $158,080 for four years. There are additional resources currently available to help each family find a solution for their college planning needs. Please visit this Merrill Edge website to learn more.

Is there a way to lower our income tax if we contribute to a 529?

For federal tax returns, contributions are not deductible no matter your income bracket. However, for state tax returns, the state where you reside may offer tax breaks. Although California is not one of them, there are thirty-four states that currently offer state deductions. To learn more about which states currently offer tax breaks, please visit:www.savingforcollege.com/529_plan_details/

Any earnings generated from the 529 will be federally (and possibly state) income tax-free as long as the withdrawals are used for qualified higher education expenses. The money within the 529 can be used for any college, university, vocational school or post-secondary educational institution. According to 2013 guidelines, a beneficiary (child) can receive up to $14,000 per year per participant (mother or father), for a total combined donation of $28,000 per year. If they wish, parents can donate five years of contributions at one time. Parents will not be taxed on the gift and will not use up part of their lifetime exemption from gift or estate taxes. If parents choose to employ this option, they cannot make additional tax-free gifts to the same account for five years, but gifting the full amount at the onset gives the account assets more time for potential growth.

What expenses can be covered by the 529 if my child lives at home (can we deduct room and board, transportation, things like that?)

Qualified higher education expenses are defined by the Internal Revenue code, which you can review here:http://www.irs.gov/publications/p970/ch08.html. Basic expenses covered include: tuition and fees, books, supplies, equipment, expenses for special needs services, and room and board (students must be enrolled at least half-time). Transportation is not a covered expense. If your child lives at home, funds can be used for any of the above specified expenses. Rules state that off-campus housing is covered as long as it does not exceed the estimated off-campus expenses provided by the university. Each individual case is different, however, so please check with your personal tax advisor.

Do I need to buy a specific state 529 or are there benefits to buying from another state?

This depends on if you currently live in a state with state-income deduction benefits. Thirty-four states and the District of Columbia offer deductions. If you live in a state that does not offer state-income deductions, like California for example, you can participate in a 529 plan from another state. However, the benefits of participating in another state’s plan are dependent on your income bracket. With several education planning vehicles available, it can be difficult to know which is right for each individual and their family. We encourage those planning for funding their child’s education to review all of their options with a financial advisor before deciding. This will ensure that the vehicle complements their overall long-term financial strategy, while allowing them to balance short and long-term financial needs. Working with a trusted financial advisor ensures that people understand all of the investment options available to them, and determine which meets their needs.

What state has the most attractive 529?

This is dependent on personal financial details of each participant. These factors include: income bracket, state where you reside and where your child elects to goes to school. In addition to the state tax deduction, other important factors to consider are: expense ratio of plans, age weighted investment option, and flexibility, breadth and performance of fund choices. To compare the details of each state’s 529 plan, please visit: www.savingforcollege.com.

What if all my children finish college and we still have a little left in our 529 account?  What happens to that money?

If this happens, a participant can allocate the money to another beneficiary or the money can be removed with a ten percent penalty on a portion of the assets. The ten percent penalty is taken on the growth of the asset and that money is taxed as ordinary income. However, clients should always consult with their personal tax advisor before making any tax-related investment decisions. Merrill Lynch encourages parents to develop a trusted relationship with a financial advisor so as to best maximize their education assets.

How can grandparents and relatives take advantage of contributing to a 529?  Do they get any tax breaks?

Grandparents and relatives can also contribute to a separate 529 plan, or in some cases, deposit money into an existing fund. Similar to when parents gift money, these contributions are not deductible on federal tax returns. They may, however, be eligible for state tax breaks depending on the state. Some plans allow third party contributions (parents or relatives), i.e. the parent is the owner of the plan, but grandparents or relatives can also contribute. However, if this is the case, third parties are not able to receive state-income tax benefits.

What are some advantages to having a 529 rather than putting aside money into a college savings plan?

First, when it comes to any long-term savings goal, the mantra is ‘the earlier the better.’ The age at which parents start saving will affect how much they need to invest in order to meet their goals. While paying for a child’s higher education is a priority, parents should not let it compromise their own financial stability. By getting an earlier start, parents can minimize the amount they need to allocate to their college fund each month because they'll be investing over a longer period of time.

One reason to have a 529 plan is because it offers the flexibility of high limits on contributions and sometimes tax benefits. With a 529 plan, the donor retains control of the assets and the assets inside a 529 grow tax free if used for approved higher education costs. The 529 is widely known as the most popular higher education savings tool. According to the Financial Research Corporation, by the end of the third quarter of 2012, Americans had invested $163.7 billion in 529 plans, and that number is expected to grow to $237 billion by 2015.

With a custodial account (UGMA or UTMA), the money can be used at any time when applied to the standard well-being of the child, not just during secondary education. However, in terms of financial aid, the UGMA/UTMA is an irrevocable gift to the minor, which ultimately deems the money the beneficiary’s property. One of the biggest differences between the UGMA/UTMA and 529 plan is that when applying for financial aid, schools view thirty percent of the money in the UGMA/UTMA account as the child’s property versus only five percent for the 529 plan. With the UGMA/UTMA plan, if a child were to apply for financial aid, the possibility exists that the school would evaluate the child to already have ownership of a significant amount of money, which in turn would drastically reduce their ability to receive additional funding. Another big difference between the two plans is that all assets within the 529, no matter the state you live, grow tax free and distributions used for qualified educational costs are also tax free. With the UGMA/UTMA account (depending on the size of the account), the student and/or parents may be subject to taxes while the fund is growing and the distribution is also taxable. The structure of the 529 plan is superior to the UGMA/UTMA account in the ability to grow assets tax-free (not tax-deferred). Therefore, it’s important to work with a financial advisor to determine which option is the best one for your unique situation.

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