by Mary Lago, CFP®, CTFA
Principal
Wealth Management Chair
If you have college-bound children or grandchildren, you are likely aware of the benefits of 529 accounts, which include but are not limited to tax-free growth of investments, tax-free withdrawals when funds are used for qualified education expenses, potential state income tax benefits, expanded gifting options with superfunding and the flexibility for the owner to transfer funds to family members.
Once you have decided to establish a 529 account, there are a few key questions that should be addressed. For example, upcoming changes to Free Application for Federal Student Aid (FAFSA) rules may bring up additional considerations pertaining to account ownership. These and other considerations are outlined below:
Where should the account be established?
How much should be funded into the account?
How should the funds be invested?
Who should be the owner of the account?
Selecting the Right Plan
When evaluating which 529 plan to use, you will want to explore which plan is right for you. For example, if you want to prioritize state income tax savings, you might select a plan that is sponsored by your state of residence. For example, in Oregon, the maximum tax savings for 2022 is a $300 tax credit, with the benefit based on the adjusted gross income of the donor and the total amount contributed. These savings are available to Oregon residents only when contributions are made to plans sponsored by the state of Oregon. You may also want to consider ease of administration when choosing a 529 plan. Some individuals prefer to forgo any state tax benefits for the convenience of consolidating assets or support with administrative matters. These and other factors are addressed in more detail in a recent post.
Funding Amount
Determining the proper funding amount is a complex and imprecise art. Ultimately, you would need to know a number of things, such as if the child will attend college, when that would be, which school, how much tuition rates and other expenses will increase each year, how many years they will attend, if they will choose to continue with graduate school, the amount of any future financial aid and much more. As a convenient starting point for discussions, Ferguson Wellman and West Bearing can assist with these calculations by using your assumptions and a firm-developed reference guide.
Investment Strategy Selection
While each 529 plan has unique investment options, every plan provides the opportunity for more aggressive investment strategies or more conservative market exposure. Generally speaking, the most aggressive options, i.e., plans with higher equity exposure, will be preferable for young beneficiaries with long investment horizons. Many plans also offer age-based strategies so that exposure to higher risk asset classes begins at a higher level and is reduced over time as the student ages. However, other factors such as the student’s reliance on the funds for the ability to attend college can also impact the proper risk exposure, with some owners preferring to make their own allocation decisions based on perceived market opportunities or other criteria.
Source: iStock
Ownership of the Account
In light of recent changes to FAFSA rules, deciding on the most appropriate owner of the 529 account has become more nuanced. Parents are commonly named as the account owner to allow them to approve or reject distributions from the account and transfer funds to other family members, if desired. Moving forward, this structure could reduce financial aid in relation to other ownership options, such as grandparent-owned plans. Historically, cash distributions from non-parent and non-student-owned 529 accounts have been counted as cash support/untaxed income, which could reduce aid eligibility by up to 50% of the amount of the distribution. However, starting with the 2024-2025 school year, FAFSA rules will not require students to report distributions from non-parent/non-beneficiary owned 529 accounts. This means distributions starting in 2022 will be treated differently as FAFSA includes distributions that were made two years prior to a school year. It is worth noting that grandparent 529 plans are still considered on the CSS profile, which is used by about 200 private colleges to award their aid. If other student or parent resources are likely to eliminate financial aid from third parties, then the decision of who owns the account might be more heavily weighted based on the desired control of the account rather than potential impact to financial aid.
As always, if you have any questions about 529 plans and a college funding plan, we encourage you to reach out to your portfolio manager.
Source: Ferguson Wellman Capital Management
Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.