COLLEGE SAVINGS 101

Savingforcollege.com

529 plans: Underappreciated Benefits Part I
http://www.savingforcollege.com/articles/529-plans-underappreciated-benefits-part-1-701

Posted: 2014-12-11

by Joseph Hurley

Financial Professional Content

When Congress in 2001 transformed 529 plans from being tax-deferred vehicles into being tax-free vehicles, I'm not sure they contemplated an environment in which investment returns might regularly outpace increases in college costs.

After all, we were all used to 6% annual college increases prior to the 2001 EGTRRA. Meanwhile, the S&P 500 Index in that year (2001) fell by 17% after dropping 2% the previous year.

Look at where we are now. Data from the College Board shows that 2014-15 average tuition rose only 2.9% at 4-year public universities, following a 2.8% increase in 2013-14. And at private 4-year colleges, tuition for 2014-15 rose by 3.7% after a 3.9% increase the year before.

The S&P 500 Index rose by 30% in 2013, and so far this year is up nearly 10% even after Wednesday's selloff.

As college costs moderate--will they ever start falling?--the odds get better that your clients' 529 accounts will increase faster than college inflation.

If a 529 account earns 7% a year, on average, and the tuition at the particular college a child eventually decides to attend increases at a 3% rate, the excess return (4%) can be withdrawn tax-free, provided that gross withdrawals do not exceed adjusted qualified higher education expenses (AQHEE).

It's actually quite extraordinary.

If Congress had thought about it more, we might have seen some sort of cap placed on the amount that could be withdrawn tax-free, perhaps tied to average college inflation rates. But that did not happen, giving 529 plans special appeal as college costs begin to soften.

I'm sure some political observers will say I am off base: Congress never intended 529 plans to be a mere hedge against college cost increases. Rather, they argue, the tax exclusion for qualified withdrawals was enacted to provide an incentive for Americans to begin setting aside dollars in college-savings accounts.

And perhaps they are correct. Either way, it is still an extraordinary benefit and one you might want to point out to your clients.

Financial Professional Content

When Congress in 2001 transformed 529 plans from being tax-deferred vehicles into being tax-free vehicles, I'm not sure they contemplated an environment in which investment returns might regularly outpace increases in college costs.

After all, we were all used to 6% annual college increases prior to the 2001 EGTRRA. Meanwhile, the S&P 500 Index in that year (2001) fell by 17% after dropping 2% the previous year.

Look at where we are now. Data from the College Board shows that 2014-15 average tuition rose only 2.9% at 4-year public universities, following a 2.8% increase in 2013-14. And at private 4-year colleges, tuition for 2014-15 rose by 3.7% after a 3.9% increase the year before.

The S&P 500 Index rose by 30% in 2013, and so far this year is up nearly 10% even after Wednesday's selloff.

As college costs moderate--will they ever start falling?--the odds get better that your clients' 529 accounts will increase faster than college inflation.

If a 529 account earns 7% a year, on average, and the tuition at the particular college a child eventually decides to attend increases at a 3% rate, the excess return (4%) can be withdrawn tax-free, provided that gross withdrawals do not exceed adjusted qualified higher education expenses (AQHEE).

It's actually quite extraordinary.

If Congress had thought about it more, we might have seen some sort of cap placed on the amount that could be withdrawn tax-free, perhaps tied to average college inflation rates. But that did not happen, giving 529 plans special appeal as college costs begin to soften.

I'm sure some political observers will say I am off base: Congress never intended 529 plans to be a mere hedge against college cost increases. Rather, they argue, the tax exclusion for qualified withdrawals was enacted to provide an incentive for Americans to begin setting aside dollars in college-savings accounts.

And perhaps they are correct. Either way, it is still an extraordinary benefit and one you might want to point out to your clients.

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