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Opening a 529 College Savings Plan Is Better Late Than Never

If you wonder whether it’s too late to start saving for your child’s college education—the answer is no. Whether your child is a newborn or already starting college, a 529 account may provide some tax benefits. Here are a few things that parents of older children may consider when opening a 529 college savings account and contributing to it.

The 529 Account Owner Might Matter

Most parents of college-age children fill out the Free Application for Federal Student Aid (FAFSA). This application evaluates your income, family assets, and other financial factors to calculate your expected family contribution (EFC). In general, the higher your income and assets, the higher your EFC and the fewer need-based grants and scholarships that may be available to your child wanting to become a college student.

A 529 account that a parent or a dependent child owns is the parent’s asset for FAFSA purposes. This rule means that a 529 account with a large balance may increase a family’s EFC and decrease the need-based aid that might otherwise be available.

A grandparent-held 529, on the other hand, is not countable as a student’s or parent’s asset; however, any funds withdrawn from the account are the student’s income. This accounting means that it could be worth talking to a financial professional when opening a 529, as your circumstances may determine the taxes and financial aid considerations based on who owns the account. 

529 Funds Are Tax-free When Spent on Qualified Expenses

Because contributions to a 529 plan are from money after paying taxes, they are usually exempt from federal tax upon withdrawal.1 This tax exclusion includes dividends and gains. However, 529 funds are only for qualified expenses, such as tuition, room, board, fees and books. They might be subject to taxation and a 10% penalty on any unqualified withdrawals used for other things. It is important to carefully review the terms of your 529 account to ensure that any withdrawals qualify under your plan’s rules.

A Limited Amount of 529 Funds May Be Used To Repay Student Loans

The shorter your investment horizon, the riskier it might be to invest your college funds in anything with the possibility of high volatility. For example, you would not want to invest your child’s entire college account in a stock market index fund just before a major correction. In some cases, it may make more sense for your child to take out student loans to cover their education, then use 529 funds to help repay a portion of these student loans. 

Federal regulations in 2022 allow students to use up to $10,000 of 529 funds to make student loan payments.2 This is a lifetime per person limit, so it may not work for those who want to further their education after college. 

For students who qualify for subsidized-interest or low-interest Stafford loans while in school, keeping 529 funds invested for additional years while using low-interest loans might be worth considering.

Sources

1 https://firstly.com/articles/got-a-teen-its-not-too-late-for-a-529-savings-plan/

2 https://www.investopedia.com/articles/personal-finance/020217/can-i-pay-student-loans-my-529-plan.asp 

Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.

Investing involves risks including possible loss of principal.

Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by WriterAccess.

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