Financial
Jun 9, 2022

The ABCs of 529s

Sponsored Content provided by John B Zachary - Wealth Advisor, Pathfinder Wealth Consulting

For this article I wanted to take a break from talking about recessionsinflation, and market volatility, in favor of a more encouraging topic: planning for the financial well-being of the next generation. The school year has ended in New Hanover County and many recent high school graduates are getting excited about their fall plans, whether it’s attending a university, community college, or trade school. 

There are a lot of factors that go into planning for college, from finding the best cultural fit for you/your student to figuring out how to pay for it all. For now, I’m going to focus on the financial side. As an initial note, North Carolina’s college planning website, College Foundation of North Carolina, has many great resources to help you and/or your child plan for college. You can find help choosing a career path, applying for, and paying for college, and applying for financial aid and scholarships. 

When talking with clients about planning for college, the conversation usually starts with college savings plans, specifically the “529 plan.” A 529 plan is a tax advantaged investment and savings plan designed specifically for educational expenses. Note that I wrote “educational expenses,” not just “college expenses,” because there were recently some regulatory changes that now allow you to use 529 funds for qualified K-12 schools (up to $10,000 per year, per child) as well as some other things like student loans (up to a $10,000 lifetime maximum). The tax advantage of the plan is that any money you invest in a 529 plan grows tax-free, if used for qualified expenses. 

To add some complication, each state has their own state-sponsored 529 plan, but (and this is important) you don’t have to reside in the state to use a state’s 529 plan. The only case where it would make sense to use the plan from the state that you reside, is if your state allows an income tax deduction for contributions (several years ago, North Carolina eliminated the income tax deduction for 529 contributions to the CFNC plan). Also, there is no requirement that you use money from a state-sponsored 529 plan for colleges in that same state. For example, living in North Carolina, I can use the Alaska plan to fund North Carolina universities.

However, there are some downsides to consider. One disadvantage of 529 plans is that any money you contribute MUST be withdrawn for “qualified expenses.” Otherwise, you’ll be subject to income tax and penalties on the earnings. So, it’s important that you don’t overcontribute to a 529 plan, to risk being penalized at the end. 

You may wonder how to determine the correct amount to contribute so you don’t overfund the account. The first step is determining your preferences for funding educational expenses for your beneficiary/ies. If we’re talking about college, decide whether you want to cover ALL the costs (which would generally include tuition, books, and room and board) or only specific expenses. Fortunately, there are plentiful resources to help you determine the ballpark costs. CFNC has a great College Savings Estimator that allows you to choose a specific university to estimate costs, or keep it simple and use state averages. Keep in mind that most colleges are lower cost if attended “in-state.” Out-of-state tuition can add thousands of dollars to the annual costs.  

Once you determine your savings requirement, then you need to determine how much to contribute to the 529 plan. Generally, even if you plan to cover all of the costs, I don’t recommend putting 100% of those savings into a 529 plan. There’s too much risk that you won’t need all those assets for education, considering other options for aid (grants, scholarships, work study, etc.) or that costs will fluctuate unexpectedly. Rather, I recommend putting half of the estimated amount in a 529 plan, and the other half in a general investment account, where you can still get the benefits of investment returns but have the flexibility of using it for other things without penalty. Keep in mind that this method does comes with a tradeoff, because general investment accounts don’t have the tax benefits of a 529 plan; however, I think the tradeoff is worth it in most cases. 

There is a lot of generalized advice out there regarding 529s plans and saving for college in general, but there is no equivalent to specific advice tailored to your individual needs and goals. At Pathfinder, we pride ourselves in making sure we know your entire situation to give advice specific for you and your family. If you would like to learn more about the benefits of working with our team at Pathfinder to build a plan for the financial future of your next generation, visit our website, or give us a call at 910-793-0616. We are here to guide you forward. 



Advisory services offered through Commonwealth Financial Network®, a Registered Investment Advisor.
 
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses. The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that a college-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified higher education expenses. The earnings portion of a nonqualified withdrawal will be subject to ordinary income tax at the recipient’s marginal rate and subject to a 10-percent penalty. By investing in a plan outside your state of residence, you may lose any state tax benefits. 529 plans are subject to enrollment, maintenance, and administration/management fees and expenses.

As a wealth advisor at Pathfinder, John works closely with folks who are planning for their future, helping them stay on their financial path.  He also specializes in developing financial plans and investment strategies for the second generation and younger families.  John has been a part of the Pathfinder team for more than 12 years, serving various roles in both planning and investments for our clients. 
 

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