Investing in Your Child’s Future: 529 College Savings Plans

Saving money for your child's college education can be intimidating. We spoke to local experts from New York's 529 College Savings  Program Direct Plan and CHET about 529 College Savings Plans, choosing investments, and more.

Saving for your child’s higher education can be a daunting task, from understanding the benefits of 529 College Savings Plans to selecting low- or high-risk investments to distributing the money for educational expenses. Daniel Reyes, head of education savings for New York’s 529 College Savings Program Direct Plan, and Pamela McNulty, 529 College Savings program manager for TIAA-CREF’s Connecticut Higher Education Trust, answer frequently asked questions about New York and Connecticut 529 College Savings Plans.
 

What is a 529 College Savings Plan and how does it differ from a regular savings account or high-interest bank certificate?

Reyes: A 529 College Savings Plan is typically sponsored by the state and it enables families to invest for college while deferring some federal and state income taxes. A 529 offers potential state income tax benefits. Taxpayers can receive state tax deductions on contributions—up to $5,000 for single filers or $10,000 for married couples filing jointly. A 529 also gives you an opportunity for tax-deferred growth—provided that the earnings are used for qualified higher-education expenses, you don’t pay federal or state income taxes on the earnings accrued during the investment life in the plan.

Will I incur gift tax for the money I contribute to my child’s 529?

Reyes: 529s actually have gift tax exclusion. If you’re a filing as single, you can give up to $14,000 and if you’re married and filing jointly, you can give up to $28,000 any year without incurring any gift tax. And 529s have another unique benefit: You can give a large lump sum for five years at once, so that would be $70,000 for an individual or $140,000 for a married couple filing jointly, provided that another gift isn’t made in the next five years.
 

What’s the best way to compare 529 plans from different states?

Reyes: The first thing to do is take a look at your own state’s 529 plans to see if there are any applicable state tax benefits that you could reap by having your plan in that state. The second thing to look at is the cost of the plans. Like mutual funds, 529 plans have expense ratios. You can compare the costs across different securities by looking at the expense ratios. The other thing to look at is the investment lineup. Some 529 plans feature a mix of both passive and active investment options—index funds versus active mutual funds.
 

When should I open a 529 College Savings Plan for my child?

Reyes: We tell people to start as soon as they possibly can. I’m actually going through the process myself. My wife and I are expecting a child, and we’ve already opened up a 529 account for the child. If the child hasn’t been born yet, you can start a 529 plan by naming yourself as the beneficiary. Once your child is born, you can change the beneficiary over to him or her.

Who else can open a 529 with my child as the benefactor?

McNulty: Anyone can open an account on behalf of a child. It does not have to be a parent or grandparent.
 

Can one child be the beneficiary of multiple accounts? How does that impact my child?

Reyes: It is done, and it is something that we see pretty frequently. It gets a little nuanced so the financial aid formula can be a little tricky sometimes, but generally speaking, having multiple 529 accounts shouldn’t materially impact a student’s financial aid eligibility.

What is the minimum to open and contribute to a 529?

Reyes: $25. Each subsequent contribution must be at least $25, unless you’re making your contributions through an automatic payroll deduction. In that case, contributions can be as little as $15 per pay period.
 

Who can claim state income tax benefits on 529 contributions? While parents, relatives, and friends can all contribute to a child’s 529 plan in both Connecticut and New York, not everyone can receive tax benefits. In Connecticut, anyone who lives, works, and pays taxes in Connecticut can claim the state income tax deduction (up to $5,000 for those filing as single; $10,000 for those filing jointly). In New York, only the account owner can claim a state income tax deduction.

I want to select fairly aggressive investments for my son’s 529 because he is young, but I worry that if I see that we’re losing money at some point I will feel devastated. How can I tell how much risk I should take on?

McNulty: All 529 College Savings Plans offer an age-based option, which is the most popular option simply because it is a well-diversified portfolio with stocks and bonds. At a younger age, the account is invested more aggressively, maybe 80 percent stocks and 20 percent bonds. As the child nears college-age, the investments move toward a more conservative route, maybe 80 percent bonds and 20 percent stocks.

In addition to those age-based options, each plan might offer a pure fixed income fund that’s all in bonds, an equity index, or an international index. The account owner can elect to put all the money in one fund or they can divvy up the contributions among multiple investment options depending upon their own risk tolerance and the age of the beneficiary. With the CHET program, we have a risk-tolerance questionnaire on the website to assess what an account holder’s risk tolerance is. It will show whether they’re a conservative, a moderate, or an aggressive investor.
 

If a family emergency comes up, can I withdraw money from the 529?

Reyes: When you have to pull out money for a non-qualified educational expense—meaning it’s not tuition, books, room and board expenses, or school supplies—the income that you’ve earned on your investments would be subject to federal and state income tax at that time as well as a 10-percent penalty on the earnings you withdraw. And that’s only on the income, not on the contribution amounts that you’ve made because the contribution amounts that you put in were added after taxes.

How will using 529 money towards my child’s education affect financial aid from a college or university?

McNulty: It depends upon the institution the student is attending and what its rules are. If the account is in Grandma and Grandpa’s name, it is considered student income when money is withdrawn, so it may reduce the needs-based aid that your child would receive. For the situation where it’s the parent’s account with the student as the beneficiary, it does not count as student income. In that arrangement, there’s less impact on needs-based aid, so gifting into a parental account may be an option.
 

Can money from a 529 be used at private and state universities?

McNulty: 529s are incredibly flexible. So you can contribute to the plan and use those funds at any school, community college, four-year university, state institution, private institution, out-of-state institution, and even some colleges and universities abroad. It can also be used for trade schools and technical schools. So any accredited institution, anywhere in the U.S., and some abroad.
 

Can the 529 savings only be used for tuition?

McNulty: It’s comprehensive, so you are able to use it for tuition, room and board, fees, expenses, anything that’s required for enrollment at the university is considered a qualified higher-education expense.

Does money from a 529 have to be paid directly to the school?

Reyes: There are two options for withdrawing. The one that we see most people leverage is sending it directly to the school. The other option is sending it to the account owner. Whenever we send money to the account owner, we advise them to keep their receipts as they’re purchasing school supplies or writing the check out for tuition so they can evidence that the money was used for qualified higher-education expenses.
 

If a family saves more money than the child ultimately needs for college, what happens to the money?

McNulty: We would love to see that because that means the family was really committed and values higher education! If all the money saved isn’t used to pay for college, there are a couple of options. The money can be transferred to another member of the family. So if there are two or three children in the family and the oldest one doesn’t use all the money, it can be transferred with no tax penalty to another member of the family. The parent themselves can use it for graduate school. The parents could keep the account and if they have a grandchild, the grandchild could be named beneficiary. If you do decide to take the money out of the account, you would have to pay the tax on the earnings and an additional tax of 10 percent.

If a relative opens a 529 for a child when they are an infant, but the child is later diagnosed with a special need and can't attend college (and there are no other children to transfer the funds to), will the family still need to pay the tax on the earnings, or are the taxes waived because of the special case?

Reyes: In the situation where the beneficiary with special needs can't attend college and there is no other family member to transfer the funds to, the account owner would need to process a non-qualified withdrawal to access the money saved, and the earnings would still be subject to any applicable state and federal taxes. For non-qualified withdrawals, a 10-percent penalty typically applies to the earnings (amount included as income), but in the case of the beneficiary having special needs and being unable to attend college, the 10-percent penalty is waived.

If I opened a 529 in New York and moved to New Jersey or Connecticut a few years later, should I move my plan to the state where I now live?

Reyes: There is no benefit or detriment to keeping it in New York, really. Say for instance that you live in NY and work in NY and then you moved over to NJ, but you still work in NYC—and therefore still pay NY state income taxes—you would still be eligible for the deduction on your NY state income taxes. So in that case you would still reap that benefit. We always tell people to consult their tax advisor when it comes to situations like that, though.
 

What do you think is the most common misconception about 529 Plans?

McNulty: That it’s a complicated savings vehicle. I think there’s also the misperception that parents need a lot of money to open an account or that it’s too late to save. We believe that it’s never too late to save because anything that you can save on your child’s behalf reduces potential loans that he has to take out. It gives him a financial foot up that ultimately is going to impact what he’s going to be able to do once he gets a job in regards to paying back student loans, funding his first home, or funding his retirement account.

Reyes: One of the biggest misconceptions we hear about 529 plans is that you have to go to a university in the state where the plan was opened. I think another big one we hear is that accumulating assets in a 529 plan will lead to the detriment of the child when they apply for financial aid. That’s the biggest thing that we hear. 529 assets are typically counted as assets of the parent. So people worry that if they save, their child won’t be able to receive financial aid, not understanding that that financial aid is given in the form of loans and sometimes grants.