When and How to Use a 529 College Savings Plan
by Jason Dean
You don’t have to be a Ph.D. to know that the cost of college tuition has increased tremendously over the course of the past decade. In fact, at a recent annual rate of 6%, the cost of college has outpaced inflation, savings, and most investments! Experts estimate that four years at a private university will cost as much as $400,000 by 2025, so obviously, parents should be saving — or should they?
Savvy financial advisors don’t steer their clients into 529 College Savings Plans unless the clients meet both of the following criteria: 1) They’ve maxed out their IRA and/or 401(k) contributions, and 2) Their child is unlikely to qualify for financial aid. This is because 529 plans can count against students when it comes time to receive federal financial aid for college, and even student loans!
Section 529 plans can be thought of like IRAs. The difference is that while the person who opens the account is the owner and controller of it, he or she must name a beneficiary — which can be a child, grandchild, or even themselves. The beneficiary can use the funds in the account to pay for college (including room, board, and books), and if he/she does so, there is no federal income tax on the investment earnings.
The catch, of course, is that a parent’s assets count against a child when applying for need-based financial aid. In many cases, socking $1 away in a 529 plan may just take $1 out of your child’s potential financial aid. Therefore, it is far better for parents to first max out their IRAs, which, as retirement assets, are not counted against their children in regards to need-based college aid.
The best way to utilize a 529 plan, if applicable, is to have a grandparent own and control the account. As of July 1, 2006, 529 accounts are considered assets of the owner/controller, not the beneficiary. This still hurts children whose parents own the accounts, but not grandparents. Grandma can be as rich as Leona Helmsley, but if her son is as broke as MC Hammer, then Lil’ Hammer can still qualify for financial aid — the assets are grandparents are not taken into account.
For more on 529 plans, see this great article, which was an entry in the 111th Carnival of Personal Finance. In it, the author considers establishing 529 accounts for his nieces and nephews — a smart move, considering the generous act won’t simply result in the government providing less aid to the children.
With the 529 plan, we can once again see how a well-intentioned government program, in this case financial aid for college, leads to unintended consequences. Why should parents who are responsible and save for college be penalized? Maybe the problem is too much financial aid, not too little. After all, one of the things that has fueled the rampant growth in tuition costs is “free money” from the government. When people are made to pay their own way, they tend to spend more wisely and demand greater value. Although it’s counterintuitive, perhaps the only way it will cost less than a half million to send your newborn to school is if financial aid is limited to only the neediest of the needy, or abolished altogether. What do you think?