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5 Reasons Why 529 Plans Are Great for College Savings Thumbnail

5 Reasons Why 529 Plans Are Great for College Savings

Looking at college projections for your children (particularly if they are young) can raise the blood pressure of even the most cool-headed parent. And while the rate of tuition inflation is ultimately out of your control, there are things you can do to put yourself in the best position possible when that tuition bill eventually comes due. One of the most effective ways to prepare for that day is to save to a 529 plan. Although there are many reasons to love 529 plans, here are some of our favorites. 

1. Income Tax Benefit Today

While 529 contributions are not deductible for federal income taxes, many states offer income tax deductions for contributions. In fact, more than 30 states offer such incentives. In our home state of Michigan, contributions are deductible up to $5,000 per year for an individual and $10,000 per year for married couples filing jointly. Considering the state’s income tax rate is 4.25%, this implies up to $425 in income tax savings each year.   

2. Tax-Free Growth

In addition to a potential state income tax deduction, money contributed to 529 plans grows tax-free. This means you will not pay taxes on the appreciation (capital gains) or income generated by your investments. Over time, being able to avoid taxes on such income and gains materially improves investment returns.

3. Tax-Free Withdrawals

Not only does money invested in 529 plans grow tax-free, it can also be withdrawn tax-free when used for qualified education expenses, including tuition, books, and room and board. Coupled with tax-free growth of the account, these twin tax benefits of 529 plans help ensure the money you save for college goes as far as possible.  

4. High Contribution Limits

Although there are restrictions on the amount of 529 plan contributions you can deduct for state income taxes each year, unlike retirement accounts such as IRAs or 401ks, there are no annual contribution limits for 529 plans. Keep in mind that contributions are considered gifts for tax purposes, so contributions above $15,000 annually per beneficiary (or $75,000 over a five-year period) will be counted against your lifetime gift exclusion. However, the good news is that the current lifetime gift exclusion is $11.4mn per individual, so this is a non-factor for most people.

5. Flexibility

Many people don’t realize how flexible 529 plans are. For starters, your contributions are not restricted by your income. Plus, you also aren’t limited to using your state’s 529 plan – you can even have multiple 529s in multiple states for the same child. In fact, some people contribute to their home state’s plan up to the state income tax deduction limit, then contribute excess funds to another state’s 529 if it has better investment options. Lastly, 529 plans allow you to change beneficiaries, so if the account is no longer needed for the original beneficiary, the assets can be transferred to other family members.

Conclusion

There is a wide range of opinion among parents about how much, if anything, they want to contribute toward their children’s education. For some parents, paying for everything is the goal, while for others, the approach is some combination of parent and child contributions. Regardless of how much you plan to save for your children’s college, it makes sense to do so in a way that maximizes how far those dollars go. And don’t worry, contributing to a 529 plan doesn’t limit the chances of your child having that junior year growth spurt followed by a full-ride athletic scholarship.

 

About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.