What is a 529 Savings Plan?
529 savings plans are also known as qualified tuition programs, designed by the government to encourage saving for education costs of a designated beneficiary, typically one’s child or grandchild.
These plans are optimal because of the tax-advantaged perks they come with, which allow the investment to grow tax-deferred, and withdrawals for the use of covering the beneficiary’s college costs to be federally tax-free. Maximize your 529 plan by taking advantage of all tools and benefits that come with the plan.
1. Capitalize on state tax deductions.
While 529 contributions are not eligible for deduction on your federal tax return, you can deduct your savings plan contributions on your state income tax return.
Most states have a generous December 31 deadline for making contributions, meaning that residents can make contributions year-round and receive their state tax break. However, residents of Georgia, Mississippi, Oklahoma, Oregon, or South Caroline have only until April 15 to make contributions that are eligible for tax deductions on their state income tax return, so if you’re the holder of a 529 savings plan, be aware of your state’s stipulations, and contribute accordingly.
Also, tax reporting is simplified for holders of a 529 plan, so you won’t need to fill out a Form 1099 to report taxable or nontaxable earnings until the year you choose to make withdrawals.
2. Establish a modest savings goal, and make regular contributions.
Decide on a modest savings goal, and start working toward it. If you can, set up an automatic deposit each month through your checking account. Having a system in place to deposit regular transfers from your account towards the plan will make it easy to contribute on a consistent basis.
3. Choose an age-based investment option.
Age-based investment options are ideal for account holders who want to protect their funds from untimely market downturns, and reduce the equity-exposure of the account as the beneficiary gets closer to attending college. It’s common for the custodian of a 529 plan to switch investments, for reasons such as aligning one’s 529 account with their own financial situation and risk preferences.
If you’ve rethought your investment option, and are looking to switch investments, the start of a new calendar year makes you eligible to make a once-per-year investment change in your existing 529 account. A clever way of avoiding the once-per-year limitation is to choose another child in the family to make the beneficiary of the account.
Once you switch options, you can simply change the beneficiary back to the original child.
4. Make good use of your rollover privileges.
Be on the lookout for better 529 savings plans (compare here), and make good use of your rollover privileges when you choose to switch. You can use your once-a-year rollover to change your current plan, but the IRS mandates that any beneficiary must wait a full 12 months between rollovers. However, you can change beneficiaries (as explained in #3) and avoid the limitation.
One thing to note is that before going through with a rollover, it’s wise to check your state tax rules, as you may be eligible to deduct rollover contributions through your home state plan. However, you may also have to pay a “recapture” tax on rollovers out of your home state plan, so check what the rules are in your state to foresee any surprises.
5. Stay on top of your 529 contributions.
Make sure not to exceed the $14,000 gift-tax annual exclusion, as contributions to a 529 plan must be combined with other types of gifts made during the year, and totaled.
Contributions exceeding $14,000 during the year can be treated as forward-gifting five years, given that you fill out Form 709, the gift-tax return, and make a “five-year election.” With this tactic, a parent can contribute up to $65,000 and a married couple can contribute up to $140,000.
6. Make your friends aware of the fund.
Give friends and family the option to donate to the fund as holiday or birthday gifts for your child. Let them know you have established a 529 account for your child, and that additions to the fund are welcome.
Most 529 plans are equipped with procedures for accepting third-party contributions, and independent services such as GradSave make it easy to collect contributions and spread the word.
7. Make your child aware of the fund.
While you don’t want to give your child access to all the household fiscal information, it can be beneficial to let your child know that you’ve set up a special account dedicated to saving for their higher education costs in the future.
A child who realizes what a big undertaking this is will feel appreciative, and possibly demonstrate their gratitude and pride by contributing part of their own chore money or allowance.