529 plan for older, 'iffy' students

By: Savingforcollege.com

Q:

Dear Joe, I have something of an unusual question regarding 529 plans, designed for funding college educational expenses. I'm considering opening a 529 plan for myself (a 35-year-old single female) as a means of putting away some additional money. I may, at some point, decide to go back to school (I have no children and do not plan to have any, so my question is only in reference to myself). In fact, while I have no plans for a master's degree, I could see myself being quite happy spending a significant amount of time on educational pursuits in my retirement. I've read the overviews on 529 plans and understand that I would, eventually, have to pay a 10 percent penalty (plus the regular taxes) on the earnings when distributed if I didn't use it to pay for educational expenses. Still, I'm currently maxing out my 401(k) contributions and I think this may be a viable option to further my retirement fund, even if I never decide to go back to school. What are you thoughts on this? Is there any more serious tax complication than what I'm reading in the FAQs regarding 529 plans? Can I even open a 529 plan for myself? And over the long haul, would I be better off to invest in an IRA or some other vehicle, even if I decided to use the money for education at some point down the road? Thanks in advance for your advice! -- D.B.

A:

Dear D.B.,
I heartily endorse your plan. 529s are flexible enough to accommodate the educational aspirations of adult Americans, even if you cannot be certain you will ever return to school. In fact, having the money set aside in a 529 plan may ultimately spur you to enroll in a college course, whether it's to pursue a degree or not.

I can point to my own family's experience as proof. When our kids became teenagers, my wife decided to return to school for a master's degree, which has helped her to advance her career in nursing. She occasionally talks about going back for even more schooling. And, yes, my wife does have a 529 account that names her as beneficiary. Even if she never returns to the ivory halls, she can keep the account intact for the educational needs of our children, future grandchildren or even great-grandchildren.

You mention you don't expect to have children or grandchildren of your own. But you may have nieces, nephews or other family members with educational aspirations. If you at any time decide to redirect your 529 funds to another family member, it will be an easy matter to change the beneficiary on your account or make a partial rollover to an account with another family member named as beneficiary.

In the "worst case," you will scrap your idea to return to school and instead use your 529 account for noneducational purposes. The account growth will be subject to ordinary income tax and an additional 10 percent tax if you withdraw it on a nonqualified basis.

Because of the tax and penalty, you may end up with less money than if you had decided to put your savings into mutual funds or other taxable investments from the outset. The outcome depends on several factors, including tax rates in the future, your tolerance for risk and your desired mix of stocks and bonds. Fixed-income investors will benefit more from the 529 tax break than those looking to invest in growth stocks. But the analysis must also consider the extra fees charged by most 529 plans.

Even if you currently prefer equities over fixed income, you may want to adjust your asset allocation later on. A 529 plan gives you the ability to change your asset mix at least once per year without taxes by switching investments or rolling over to another 529 plan. With mutual funds, an exchange constitutes a taxable sale.

The U.S. Treasury Department has expressed concerns about individuals using 529 plans as retirement accounts and has proposed increasing the penalty from 10 percent to 20 percent on nonqualified distributions taken more than 20 years after establishing the 529 account. If this proposal ever makes it into law, it will likely apply only to accounts funded after the enactment date.

Popular Questions

Question

Two kids, two 529 plans?

Dear Big Bill,
While it's possible to maintain a 529 plan in just one child's name, even when you intend to send more than one child to college, I generally recommend that families open a separate 529 account for each child.

That's assuming there is no additional cost to maintaining multiple accounts. If your 529 plan charges an annual or quarterly account maintenance fee, check to see if you can avoid the fee by signing up for automatic contributions through payroll deduction or electronic funds transfer)

With a separate 529 plan for each child, it becomes easier for you to tailor the mix of stocks, bonds and stable-principal investments (e.g., stable value, guaranteed principal and money market funds) to the particular ages of your children. When your older child is nearing high school graduation, you may want to ratchet down the level of market risk in her 529 plan. At the same time, you could keep a more-aggressive asset allocation in your younger child's 529 plan, accepting more risk for a potentially higher return. Many 529 plans offer "age-based" investment options that automatically make these adjustments as the beneficiary ages.

Separate accounts for your children also offer more gift-tax leeway. Since your 529 contributions are treated as gifts from you to the account beneficiary, your $15,000 (in 2018) annual gift exclusion will go twice as far with two accounts -- one for each child -- than with just one account.

Financial aid is another reason to recommend maintaining separate accounts. You wouldn't want the investments reserved for your younger child's future college expenses to count against your older child's financial aid eligibility. Be warned: The rules here are rather murky, and the impact of a sibling's 529 account may depend on the college's own policies as well on as the type of aid -- federal or institutional -- being sought.

Finally, I believe that separate 529 accounts allow for better family bookkeeping. There will never be any doubt as to your intention to help send all of your children to college. You'll avoid the uncomfortable position of being asked to explain to a curious 8th-grader why account statements are showing up in the mail with only a brother or sister's name on them. And in the event of your death or divorce, no matter how unlikely, your legal representatives and other family members will have less reason to question your actions in setting up and funding the 529 plans.

Even with separate accounts, you'll continue to have the flexibility to shift the money around in the future. You simply need to make sure that whenever funds are withdrawn from the 529 plan to pay for college they are coming from an account in the name of the child incurring the costs. It's a simple matter to change the beneficiary designation among family members at any time, transfer 529 funds between different family members' accounts or split one 529 account into two. The ability to move assets around the family is a key advantage of 529 plans when comparing other college-savings alternatives, such as Uniform Transfers to Minors Act, or UTMA, accounts.

Original Post: 2005-10-13
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Coverdell ESA vs. 529 Plan: Which to choose? (Script)

The Coverdell ESA and the 529 plan are both excellent college savings vehicles because they are both tax-free when used for college. But many families face a choice: do they use a 529 plan for all of their child's college savings, or do they use a Coverdell for the maximum amount of $2,000 each year and put any any extra savings above $2,000 into a 529 plan? In spite of its low annual contribution cap, Coverdell's are now attracting quite a few families. There are two major reasons for that. One is that only the Coverdell allows you to self-direct your investments, just like you might self-direct the investments in your IRA. The other is that in addition to college expenses, Coverdells can be withdrawn tax-free to pay for a broad range of K-12 expenses, while 529 plans are limited to K-12 tuition. This feature is appreciated most in families planning to send their children to private grade schools, which may include additional costs such as room and board or uniforms. A 529 plan, on the other hand, does not impose age limits or income limits like the Coverdell does and so overall we see a lot more money going into 529 plans than into Coverdells. Plus many savers are happy with the investment choices offered by the 529 plans and don't necessarily want to self-direct their investments. And don’t forget this: your state may be giving you a state tax deduction for using a 529 plan, but there are no states offering a state tax deduction for investing with a Coverdell ESA.

Learn more about Coverdell ESAs.

Original post date 2013-07-15
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Top 529 Plan Withdrawal Tips. (Script)

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Top 529 Plan Withdrawal Tips. (Video)

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