Truth be told - Common 529 plan misconceptions

http://www.savingforcollege.com/articles/truth-be-told-common-529-plan-misconceptions

Listed below are six common misconceptions regarding 529 plans that were featured as True/False questions in our Annual College Savings Survey. The results showed that there are still many people who are unclear about the functionality of 529 plans. In this post, we will reveal the correct answers and help clear up some of the confusion.

1. I must use the 529 plan offered by my state: FALSE

Percentage of respondents who answered correctly:

• 93% of those who currently have a 529 plan
• 74% of those who do not have a 529 plan

When opening a 529 account, it’s a good idea to look into your own state’s plan first since many states offer state income tax breaks to residents. However, don’t write off out-of-state plans. You may find better investment options and lower fees and expenses elsewhere. Although you could miss out if your state offers tax breaks, you will still reap the benefits of federal tax-free earnings and withdrawals no matter where your plan is based.

Check out your state's tax benefits here.

2. 529 plan savings must be applied toward colleges in the state where the plan is based: FALSE

Percentage of respondents who answered correctly:

• 96% of those who currently have a 529 plan
• 78% of those who do not have a 529 plan

Just as there are no restrictions as to where you can invest your 529 savings, you can spend your withdrawals almost anywhere, including some international schools. Your child’s choice of school will not affect the benefits derived from a 529 plan*. Similarly, if you have an out-of-state 529 plan and the beneficiary decides to go to an in-state school it will not affect his or her eligibility for in-state tuition.

*Different rules apply for prepaid tuition plans.

3. If my child doesn't go to college, I'll lose the money saved in a 529 plan: FALSE

Percentage of respondents who answered correctly:

• 92% of those who currently have a 529 plan
• 83% of those who do not have a 529 plan

529 savings do not have to be used toward a traditional 4-year college. If your child or grandchild doesn’t end up going to the school of your dreams, you can still use the funds toward almost any postsecondary education, including vocational schools. Chances are they will need a job and they will need some sort of schooling to be able to get it. If not, one of the best parts about a 529 plan is that you can easily change the beneficiary at any time to transfer the assets to someone who is planning on attending college.

If you truly must use the money saved in a 529 account for something other than qualified educational expenses, you will still never lose the entire amount. You will, however, give up 10% of the earnings portion to a penalty tax in addition to the incurred income tax. The principal (the amount you contributed) is not subject to tax or penalty.

Learn more about non-qualified distributions here.

4. If my child gets a scholarship, I'll lose the money I've saved in my 529 plan: FALSE

Percentage of respondents who answered correctly:

• 96% of those who currently have a 529 plan
• 89% of those who do not have a 529 plan

As stated above, you will never lose all of the money you invested in a 529 account. There is also a special exception in the event a child receives a scholarship. Money withdrawn from a 529 plan up to the amount of the tax-free scholarship will not be subject to the 10% penalty tax. You will have to pay income tax on the earnings portion, but your contribution portion will be withdrawn tax-free.

To try and avoid paying any additional tax, you keep the account open in case your child goes on to graduate school, or use the money toward other qualified expenses like books or room and board.

5. Savings in a 529 plan are considered when determining financial aid eligibility: TRUE

Percentage of respondents who answered correctly:

• 69% of those who currently have a 529 plan
• 61% of those who do not have a 529 plan
• 56% of Grandparents
• 65% of Parents

The Annual College Savings Survey revealed this to be one of the biggest areas of confusion for parents and grandparents regardless of whether they were currently investing with a 529 plan or not. When determining financial aid eligibility, colleges determine your expected family contribution (EFC) based on your household income and assets. A student’s assets are assessed at 20 percent, but parental assets are assessed at only 5.6 percent. An exception to this rule is when the savings are in a 529 plan, in which case they are assessed at the parent’s rate no matter who is listed on the account. This often makes 529 plans a more attractive option than UGMA (Uniform Gift to Minors) custodial accounts, which are considered the student’s assets and assessed at 20 percent.

Learn more about financial aid eligibility here.

6. My child can never withdraw from the 529 plan without my permission: TRUE

Percentage of respondents who answered correctly:

• 68% of those who currently have a 529 plan
• 58% of those who do not have a 529 plan
• 54% of Grandparents
• 62% of Parents

Unlike a UGMA/UTMA custodial account, the beneficiary of a 529 account has no legal rights to the funds regardless of his or her age. The person who sets up the account (the owner) has control over the investment decisions and the distribution of assets.

Compare 529 plans with other savings options.

Learn as you go

As regulations change and new products come to market, you should always be researching the most effective ways to save for college. Our goal is to provide you with the most up-to-date information and resources available to help you make sound decisions. Keep an eye out for an upcoming slideshow that will dispel even more common myths regarding 529 plans!

As a parent, grandparent or student how well did you answer these T/F questions? Were you surprised by any of the truths behind the myths? What do you think could be the biggest myth preventing others to invest with 529 plans?

Don't miss the other posts in this series!

• Annual College Savings Survey results: Direct-or advisor-sold 529 plan?
• Annual College Savings Survey results: All that you can leave behind
• Annual College Savings Survey results: Make the most of your savings
• Annual College Savings Survey results: An opportunity to educate