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When it comes to 529 plans, parents just don't understand
http://www.savingforcollege.com/articles/when-it-comes-to-529-plans-parents-just-dont-understand

Posted: 2018-1-31

by Kathryn Flynn

It's no surprise that saving for college has become an important financial priority for parents, second only to retirement. Rising tuition costs and record-breaking student loan debt in the U.S. (now over $1.4 trillion) have made it almost impossible to achieve the American Dream without proper planning.

On the bright side, many parents are actively saving. According to Fidelity's College Savings IQ survey, released last year, 72% of parents have already started putting money aside and 59% are contributing on a regular basis. But while almost half of parents (48%) are using a 529 college savings plan, data suggests they are confused about how they work, and could be making costly mistakes. Here's why:

They underestimate college costs. Everyone knows college is expensive. But how many parents really know how much it's going to cost? Not many, according to the survey. Only about half of parents said they have an idea about how much to save each month, and many were clueless about what the sticker price will be when their kids enroll: Parents of high schoolers were off by $70,000, and parents of preschoolers and younger missed the mark by $110,000.

Unfortunately, if you have kids in high school, it might be difficult to find extra $70,000 before college starts. The good news: Your savings gap is probably much smaller than you think. According to Sallie Mae's How America Pays for College report, 35% of total college costs are covered by grants and scholarships. If your kids are still young, start by mapping out a savings strategy that will help you reach your goal. Fidelity and Savingforcollege.com have free college planning calculators that will estimate a monthly savings target based on your child's age and the type of school you're saving for.

They don't always take advantage of 529 state tax benefits. Perhaps one of the most unique features of a 529 plan is that in addition to federal tax-free investment growth, you may also qualify for an additional state tax benefit.

Today, 34 states and the District of Columbia offer residents a tax deduction or credit for 529 plan contributions. Most states require that you invest in your home state's plan to qualify, but Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania offer tax benefits for residents who invest in any state's 529 plan.

Yet according to the Fidelity survey, a whopping 61% of parents aren't sure whether or not their state offers a 529 tax deduction or credit. You don't have to use your state's plan, but in some cases, it might be a smart idea. Take Indiana, for example - The state offers a 20% tax credit for up to $5,000 per year in contributions to an Indiana 529 plan. That means if a married Indiana couple with $150,000 of taxable income saved $300 a month in an out-of-state 529 plan, they would be missing out on annual tax savings of $540.

They don't know that you can make investment changes. It's true that 529 plans offer limited investment flexibility relative to other savings vehicles like Coverdell ESAs or Roth IRAs, but you aren't locked into your choices. 529 plan investors can make two investment changes within an account in any calendar year. Also, you can direct any new 529 plan contributions to a new investment option, just as long as you keep your original investments in the same place. Fidelity's survey found that 27% of parents think you're stuck with your initial investment selections throughout the life of your plan.

They're afraid of saving too much. Many parents assume that 529 plans have a "use it or lose it" rule. For some, it's a valid concern, especially if you think there's a chance your child a) won't go to college or b) will get a scholarship to cover most of the costs. But you can rest assured, no matter what happens you will never lose all of your 529 plan savings. If you take a non-qualified withdrawal, you will pay income tax and a 10% penalty - but only on the earnings portion of the distribution. If your child decides to forgo higher education, you can always change the beneficiary on the account to another qualifying family member who is planning to go to college or private K-12 school (as of January 1, 2018, families can use 529 plans to pay for tuition expenses at private elementary and high schools). If your child gets a scholarship, you can take a non-qualified distribution up to the amount of the award without incurring a penalty.

According to the survey, 31% of parents believed you forfeit any unused funds in your 529 plan, 42% didn't know you can change the beneficiary and 51% didn't know that you can take a distribution up to the amount of a scholarship without being penalized.

They think if they have a 529 plan, they won't get financial aid. Nearly half (44%) of the parents surveyed by Fidelity believe having a college fund will hurt financial aid eligibility, which isn't always true. Around the first $20,000-$30,000 (depending on the parents' age) of parent savings, no matter what type of account, will fall under the asset protection allowance and won't be counted in the Expected Family Contribution (EFC) calculation.

If you're planning to save more than the exemption, know that 529 plans owned by a parent or dependent student receive "favorable" treatment on the FAFSA. Here's what that means:

  • If you have a 529 plan worth $10,000, only a maximum of $564 would be added to the EFC. That's because 529 savings are considered parental assets, which are counted at no more than 5.64%, after certain allowances. Normally, 20% of the value of a student's assets are considered funds available to pay for college.
  • Qualified 529 plan withdrawals are excluded from federal income tax and do not have to be reported as income on the FAFSA, as long as a parent or dependent student is the account owner. Other student income, including withdrawals from grandparent-owned 529 plans, will be assessed at 50%.

If you're in the market for a new 529 plan, make sure you do your research to find the best option for your family.

An earlier version of this article was originally published on Forbes.

It's no surprise that saving for college has become an important financial priority for parents, second only to retirement. Rising tuition costs and record-breaking student loan debt in the U.S. (now over $1.4 trillion) have made it almost impossible to achieve the American Dream without proper planning.

On the bright side, many parents are actively saving. According to Fidelity's College Savings IQ survey, released last year, 72% of parents have already started putting money aside and 59% are contributing on a regular basis. But while almost half of parents (48%) are using a 529 college savings plan, data suggests they are confused about how they work, and could be making costly mistakes. Here's why:

They underestimate college costs. Everyone knows college is expensive. But how many parents really know how much it's going to cost? Not many, according to the survey. Only about half of parents said they have an idea about how much to save each month, and many were clueless about what the sticker price will be when their kids enroll: Parents of high schoolers were off by $70,000, and parents of preschoolers and younger missed the mark by $110,000.

Unfortunately, if you have kids in high school, it might be difficult to find extra $70,000 before college starts. The good news: Your savings gap is probably much smaller than you think. According to Sallie Mae's How America Pays for College report, 35% of total college costs are covered by grants and scholarships. If your kids are still young, start by mapping out a savings strategy that will help you reach your goal. Fidelity and Savingforcollege.com have free college planning calculators that will estimate a monthly savings target based on your child's age and the type of school you're saving for.

They don't always take advantage of 529 state tax benefits. Perhaps one of the most unique features of a 529 plan is that in addition to federal tax-free investment growth, you may also qualify for an additional state tax benefit.

Today, 34 states and the District of Columbia offer residents a tax deduction or credit for 529 plan contributions. Most states require that you invest in your home state's plan to qualify, but Arizona, Kansas, Minnesota, Missouri, Montana and Pennsylvania offer tax benefits for residents who invest in any state's 529 plan.

Yet according to the Fidelity survey, a whopping 61% of parents aren't sure whether or not their state offers a 529 tax deduction or credit. You don't have to use your state's plan, but in some cases, it might be a smart idea. Take Indiana, for example - The state offers a 20% tax credit for up to $5,000 per year in contributions to an Indiana 529 plan. That means if a married Indiana couple with $150,000 of taxable income saved $300 a month in an out-of-state 529 plan, they would be missing out on annual tax savings of $540.

They don't know that you can make investment changes. It's true that 529 plans offer limited investment flexibility relative to other savings vehicles like Coverdell ESAs or Roth IRAs, but you aren't locked into your choices. 529 plan investors can make two investment changes within an account in any calendar year. Also, you can direct any new 529 plan contributions to a new investment option, just as long as you keep your original investments in the same place. Fidelity's survey found that 27% of parents think you're stuck with your initial investment selections throughout the life of your plan.

They're afraid of saving too much. Many parents assume that 529 plans have a "use it or lose it" rule. For some, it's a valid concern, especially if you think there's a chance your child a) won't go to college or b) will get a scholarship to cover most of the costs. But you can rest assured, no matter what happens you will never lose all of your 529 plan savings. If you take a non-qualified withdrawal, you will pay income tax and a 10% penalty - but only on the earnings portion of the distribution. If your child decides to forgo higher education, you can always change the beneficiary on the account to another qualifying family member who is planning to go to college or private K-12 school (as of January 1, 2018, families can use 529 plans to pay for tuition expenses at private elementary and high schools). If your child gets a scholarship, you can take a non-qualified distribution up to the amount of the award without incurring a penalty.

According to the survey, 31% of parents believed you forfeit any unused funds in your 529 plan, 42% didn't know you can change the beneficiary and 51% didn't know that you can take a distribution up to the amount of a scholarship without being penalized.

They think if they have a 529 plan, they won't get financial aid. Nearly half (44%) of the parents surveyed by Fidelity believe having a college fund will hurt financial aid eligibility, which isn't always true. Around the first $20,000-$30,000 (depending on the parents' age) of parent savings, no matter what type of account, will fall under the asset protection allowance and won't be counted in the Expected Family Contribution (EFC) calculation.

If you're planning to save more than the exemption, know that 529 plans owned by a parent or dependent student receive "favorable" treatment on the FAFSA. Here's what that means:

  • If you have a 529 plan worth $10,000, only a maximum of $564 would be added to the EFC. That's because 529 savings are considered parental assets, which are counted at no more than 5.64%, after certain allowances. Normally, 20% of the value of a student's assets are considered funds available to pay for college.
  • Qualified 529 plan withdrawals are excluded from federal income tax and do not have to be reported as income on the FAFSA, as long as a parent or dependent student is the account owner. Other student income, including withdrawals from grandparent-owned 529 plans, will be assessed at 50%.

If you're in the market for a new 529 plan, make sure you do your research to find the best option for your family.

An earlier version of this article was originally published on Forbes.

 

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