Key choices to make when choosing a 529 plan
Key takeaways
Passive or static portfolio?
A child’s age and your client’s comfort with risk are the key factors when choosing investments.
In-state or out-of-state plan?
While a client’s home state plan may offer a tax deduction or credit, it’s important to consider other things too.
Contribute to an existing plan or open one?
Should the client open their own account or contribute to a parent-owned or another existing plan?
Once a client is on board with having a 529 college savings plan, there are a few key decisions to make — whether they’re a parent, grandparent, relative, or friend of the child they want to help educate. Here are three key questions to answer.
In-state or out-of-state 529 plan?
Thirty-four states and the District of Columbia currently offer a state income tax deduction or tax credit for 529 plan contributions. In all but seven, the client must contribute to their home state’s 529 plan to qualify for a state income tax benefit. Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania, however, offer tax parity. That means a client can get a state income tax benefit for 529 contributions to that state’s plan even though they don’t live in the state. While it might seem like choosing a 529 plan from a client’s home state is best, it may not always make sense. It’s important to compare the costs, investing options, fees, and tax advantages of other 529 plans too. Sometimes an out-of-state plan may have more benefits than an in-state tax break.
Passive or static 529 portfolio?
Clients need to be comfortable with the investment strategy in their 529 plan. It’s important to match the strategy to their comfort with risk. Remind clients that being too conservative for too long can be risky too. The cost of college is only going to go up. Also, do they want a more hands-on approach, where they select the investments or a set-it-and-forget age-based portfolio?
Contribute to an existing plan or open one?
Whether your client is a parent, grandparent, relative, or friend, they can either contribute to an existing one or open a 529 plan for a child. There are some things pertaining to taxes, financial aid, and control of the account to keep in mind when making a choice.
Taxes. In most states that offer tax benefits, anyone who contributes to a 529 plan can get a state income tax deduction. In 10 states, however, only the plan owner can claim a tax benefit. Having the 529 plan in the contributor’s name ensures they can get the available state tax deduction.
A client may want to take advantage of accelerated gifting. That’s when a person (relative or non-relative) makes up to five years' worth of gifts at one time — for a total gift of $80,000 per person or $160,000 per married couple –– free of gift taxes. This removes those funds from the taxable estate. Also, compared to making an annual contribution, the money has more time to potentially grow because it will be invested over a longer timeframe. This can be done by contributing to an existing account, but it may limit how much a parent could contribute, for instance, because some states do have account maximums.
Financial aid. The impact on financial aid varies depending on who owns the 529 plan (the beneficiary, the parents, or anyone else). The assets in a 529 plan owned by anyone other than the parent or student aren’t counted for financial aid purposes. (Parent-owned 529 assets count 2.6%–5.64% based on a sliding income scale and after certain allowances). Withdrawals from 529 plans, however, must be reported in the student’s FAFSA application as student income, which can reduce financial aid eligibility by 50%. Starting with the 2024-2025 award year, however, students will not need to report any financial contributions they receive, including funds from non-parent owned 529 accounts.
Control of account. Another consideration is who makes the decisions about the 529 plan. The account owner chooses the plan and the investments. They also manage withdrawals. They can change the beneficiary of the account, too, if the child decides not to go to college. This may be important to the client. If the client contributes to a plan they don’t own, they don’t have access to those funds.
Help your clients make the right choices
Making the right 529 choices can benefit your client and the child. Your clients will appreciate your due diligence. Learn more on how to connect with your clients and help them reach their college savings goals on our 529 plan resource website.
