Wednesday, January 13, 2010

To 529, or not to 529 – That is the Question

From the Desk of Joe Rollins

Over the weekend I reviewed Rollins Financial’s performance on the 529 accounts we manage for our clients. If you’re not familiar with a 529 plan, now’s the time for you to bone up on the subject. In its simplest form, a 529 plan is a deferred educational trust you would set up for someone else’s benefit. For example, the plan could provide for the education of a child, grandchild, nieces or nephews, or anyone else you choose.

For 2009, all of the 529 plans under our management had a total return of 24.52%. That’s an extraordinary return given that the gains on 529 accounts are entirely tax exempt if they are used for higher education expenses. Under U.S. tax laws, there aren’t many “free lunches.” This is an example of the best of both worlds – you provide for the cost of someone’s higher education while being tax exempt. If you use the income for the cost of higher education, the income earned is never taxed.

The more I think about the ultimate benefits of a 529 plan, the more I think there is no reason why everyone reading this blog should not contribute to one. After all, almost everyone knows someone who could benefit from the educational money that these plans provide. The best way to fund a 529 plan is not with a large sum of money; rather, funding it through monthly contributions is more advantageous. The easiest way to accomplish this is by electronic transfer directly from a cash account you maintain into a 529 account that we would invest for you. This would provide you with the benefit of dollar cost averaging into investments and should be a very successful investment tool for providing for this future education expense.

The other benefit of a 529 plan is that it is very flexible. Many people who are apprehensive about opening a 529 plan are worried that the person they’ve set it up for will not wind up not going to college or will receive a scholarship, rendering the funds unusable. 529 plans were designed to accommodate for these situations. For example, you can change the beneficiary on a 529 plan at any time. In other words, you can name someone else to be the beneficiary of the assets at any time. For example, if you have a child who decides not to attend college or if he or she has received a scholarship, you can change the beneficiary to be another of your children. You can continue changing the beneficiary to be another child if the funds continue to be unneeded. You could even change the beneficiary to one of your grandchildren if your family tree has continued to grow, but your children have not needed the funds you originally set up for them.

There is one caveat for you to be aware of if you set up a 529 plan. It is not designed for secondary education; it is solely designed for higher education. Therefore, if you’re looking for a short-term fix for private education at the secondary level, a 529 plan will not work.

A 529 plan is also an excellent estate planning vehicle. By virtue of transferring money out of your individual name into a 529 plan for someone else’s benefit, you have effectively transferred that money completely away from your estate. As long as someone else is named as the owner of the account, none of the assets (or the earned income) will be included in your gross estate for estate tax purposes. 529 plans work under the same gift tax laws as any gift to a third party. You can contribute $13,000 per year, per beneficiary to a 529 plan, gift tax free. If you are married, you and your spouse can contribute a total of $26,000 per year. For example, if you have total of 10 children and grandchildren, you can move $260,000 annually out of your estate and divided among the 10 different 529 plans you have set up. There are also complex tax rules that will allow you to contribute a high initial payment, but to keep from boring you too much, I will not explain those complicated tax laws herein.

Another benefit of a 529 plan is that they work best over a long time horizon. If you establish a 529 plan for a newborn, you will have a full 18 years before you have to consider withdrawing the money for the child’s higher education. Additionally, even after beginning to take withdrawals from these plans, it is typically not all needed within the very first year, and therefore, it has even more time to accumulate value.

The benefits of 529 plans are so convincing that I can’t imagine anyone not wanting to establish one of these plans. If you do not have children or if they are already beyond their college years, it’s still possible to set up a 529 for your grandchildren, nephews, nieces, or even a close family friend or other worthy recipient.

In a worst case scenario, you can take money out of the 529 account for non-higher education expenses or just close the account. You will pay a 10% penalty plus state and federal income tax on the gains only, but the principal is completely exempt from taxes and penalties. In essence, it is basically equivalent to a Roth IRA for educational purposes only without the annual limits.

It’s unlikely that anyone cannot afford at least $100 per month to contribute to one of these very valuable investment vehicles. I can think of nothing more valuable to a young person than to have their college education be provided for by someone so they do not have educational loans when they graduate.

If you would like for us to help you establish a 529 plan, please contact us. Aside from our nominal management fees, there is no cost to establish or maintain a 529 plan.

The above thoughts are not just my opinions – they are actually supported by facts. So, I must be right this time!