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Give the gift of a 529 Plan

Some of you have already been contributing to a 529 Savings Plan for your children. You may have been doing this for years. I’ll be honest, I didn’t even know what this was, or how to use one until after my kids were older, and only a couple of years from graduating high school. 

For those that are new, and learning what a 529 Savings Plan is, we’ll do a quick review of what this account is, what it can be used for, and the benefits. 

What is a 529 Plan?

Why is it called a 529 Plan, anyway? It’s because we are super creative! It’s cleverly named after the section of an Internal Revenue Code.  To briefly summarize, the plan originated in 1986 in the State of Michigan, when it was a Trust. It wasn’t until 1996 when it was added to the Internal Revenue Code to authorize the Tax-Free Status for tuitions that qualified. It was typically referred to as a 529 College Savings Plan, as it was intended for Higher Education to be qualified. This was a fund to which one could prepay for tuition for college. 

Changes continued to the program and additional qualifying expenses were added.  Not only Tuition but also room and board, fees, books, other equipment required for the education. In 2015 it was expanded to include a computer to be used for school and even internet access! Then, in 2017 the funds in a 529 Plan can also be used for up to ten thousand dollars of K-12 education per year!  As recently as 2019, a 529 Plan can also be used to pay student loan payments as well as the costs incurred by apprenticeships.  

Investment growth of the 529 plan is free from federal income tax, and the individual isn’t taxed when money is used for education expenses

A 529 Plan is like a Roth IRA

What makes a 529 Plan wicked-awesome, is that it behaves much like a Roth IRA, in that the money that is contributed into the plan is after-tax, and the growth is free from federal tax.  The user also isn’t taxed when the money is used for the qualifying education expenses. 

I mentioned that the after-tax continuations will grow.  See, this isn’t just an education savings account.  This is an investment account!  Yup within the 529 Plans there are dozens of funds to choose from. This can vary by the state offering the plan.  In general, the plans are made up of portfolios, and the portfolios are then made up of mutual funds, Index Funds, & ETFs (exchange-traded funds) CDs (certificate of deposits), or high-yield saving accounts. 

There are varieties of ways, and funds to select and include in the portfolio. You may elect to choose a ready-made portfolio based on how long you are saving for, or what kind of risk tolerance you have. There are age-based portfolios that automatically reduce risk when the child ages closer to their college years. 

Passive vs. Active Managed Funds

You can get super in the weeds here. There are actively managed vs passively managed funds and can choose a portfolio that may have more aggressive growth, but higher risk.  Using a financial advisor can help in selecting the best balance between growth and risk to achieve your education goals. 

There are a couple of different types of 529 plans. We have been focusing on the Savings Plan option, in that the growth is based upon the market performance of the investments in the portfolio. 

There are Prepaid 529 Plans offered in some states in which you purchase tuition at what they cost today, for use in the future. 

This is the crazy thing, in 2013 only 2.5% of all families had a 529 Education Savings Plan.  This is so easy to set up, and contribute to that it is a shame more parents, grandparents, aunts, uncles, friends or others aren’t using this investment vehicle for a child’s education. 

A good friend of mine has a daughter who is about to turn one year old.  I was invited to the birthday party, in which I do hope I see the little one smash cake into her face!  Anyway, after adding the upcoming birthday party to my calendar, I added buy birthday card and gift to my To-Do list. 

The Gift That Keeps On Giving

I thought…. What do I get a one-year-old?  I remembered back when my children were young. I recall all the “stuff” we received as gifts.  By all means, I’m grateful for all the love and generosity of our friends and family. However, there was so much stuff. Too many toys. And many things that they’ll never truly find value or enjoyment in.  So many clothes. Onesies and booties that we didn’t have room for in their dresser or overflowing closets. 

Again, I thought… What can I get this little one, that would make sense?  I’d like to give a gift that can keep on giving. Ha! I love that saying.  I looked into different financial products that would make sense for a baby.  There are 529 plans, ESAs (Education Savings Accounts), and Individual Stocks. I could even set up a brokerage account. Would that be beneficial?  I did research and landed on the Gift of a 529 Education Saving Plan that would be the best option.

Another thing that is good to know is that you aren’t restricted to the state of residence when selecting a 529 Plan. You can use a plan from any state. For example, one can use a 529 plan from Ohio, to pay for college in Minnesota, for example. There are some states that have benefits in low fees, investment performance, and allowing others (like friends and family) to easily contribute gifts to the child’s account.

Easy For Others To Contribute

I chose to open a 529 Plan in the state of Ohio. This plan had overall lower costs with no enrollment or annual maintenance fees. I easily set up the contribution from my bank electronically (or you could choose to fund the account with a physical check like a caveman) You can choose a one-time contribution or a reoccurring contribution. You can even set up a payroll deduction.

This account also allows you to use a program called Ugift.  As it says on their site, Ugift is an easy, free-to-use service that lets 529 plan account owners encourage family and friends to celebrate children’s milestones with the gift of college savings, in lieu of traditional gifts. I was surprised and happy at how easy it was.  They provided a list of what is needed to open the account and even had the option to choose if you are opening for a friend.  I selected what funds to include in the portfolio. The child is one and has 17 years to grow, so selecting aggressive growth index funds was an easy choice. This entire process only took a few minutes!

So let’s take a look how a simple gift, can truly provide a gift that keeps on giving. HA! I said it again! 

The Wonders of Compounding

If I were to make a contribution of $200, and assuming an average 8% return over the next 17 years, would grow to $740.  While that’s cool and all, let’s keep this rolling. I would continue to contribute $200 every birthday until she graduates high school.  Now you can see that a $3,600 contribution over the seventeen years would grow to nearly $7500! Boom!

Keep in mind, this doesn’t take into account other holidays and gifts that could be given from grandparents, parents, aunts, uncles, or other friends and family. 

Gifting Can Have Consequences

Also, remember these contributions are considered gifts to the beneficiary. So, they are subject to the gift tax. The first $15,000 of gifts to the child is excluded from the gift tax. There is a special rule for 529 plans, you can choose to treat a contribution up to $75,000 as if you had applied it over five years. Sometimes this is referred to as “superfunding.” Ah… Yeah, the word “SUPERFUNDING” is almost as cool as the term “MEGA BACKDOOR ROTH CONVERSION” lol. You can apply the gifts above $75,000 against your lifetime gift tax exclusion. Which as of 2021 was $11.7 million. Ummm… yeah. I’ll get on that! Hahaha.

I know what you are thinking!  What happens if the child doesn’t go to college?  The money in this account can be withdrawn for uses other than education expenses. Remember! This is now subject to taxes plus an additional 10% Penalty.  

The key is to start early! Whenever I’m asked what is the thing that I wish I knew about investing or personal finance. The answer is always I would have started earlier. 

Maybe the next time you have the opportunity to give a friend, family, or loved one a gift, you’ll choose a Tax-Advantaged 529 Education Savings Plan. 

Disclosure: I am in no way shape or form a tax or investment advisor, and this article to be served as inspiration and entertainment purposes. Please contact your own tax or investment professional regarding actual investment or tax planning.

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