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Maximizing the Tax Benefits of Saving for College

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College may seem like a long way off when your child is first born, but saving early and smartly are essential to easing that future financial burden, which according to U.S. News data, was an average $35,676 per year for private colleges during the 2018-2019 school year.1

It’s no secret college costs continue to rise and it’s important to have a strategy if you choose to fund that next phase of your child’s life. One common vehicle for saving is the 529 Plan, which can offer some exciting tax advantages.

From the federal standpoint, contributions can grow tax free if they are used for qualified educational expenses, as set by the IRS. In a traditional investment account, any gains from your investments would be subject to tax when you sell them, and any income from the investments, such as dividends or interest, would be subject to tax in the year earned.

Let’s look at a simplified example. If you use an investment calculator, start with a $10,000 investment, and assume it grows at 4% a year for 18 years, you would end up with $20,258. In a 529 account, that $10,258 growth would be tax free if used for a qualified educational expense. In addition to the tax savings, think about the fact that you only had to put $10,000 in to cover $20,258 worth of college expenses. Returns will vary, but this calculation should help you see the value in both starting early and saving tax efficiently.2

Additionally, you’re allowed to bundle your contributions and contribute more than the annual gift exclusion.  You can gift up to $75,000 as an individual, or $150,000 as a married couple, in one year to a 529. This represents 5 years of gifting the annual exclusion of $15,000 ($30,000 for married couples) in one year. You would not be able to make any additional gifts for 5 years. One of the benefits to this is that it allows the money more time to grow. We often find that grandparents like to take the most advantage of bundling some of their contributions.

Many states also provide tax advantages by allowing you to deduct your contributions up to a certain amount each year. Most states will require you to adopt their own state plan to qualify for the deduction, but seven states, Arizona, Arkansas, Kansas, Minnesota, Missouri, Montana, and Pennsylvania, allow you to receive the deduction and contribute to any state’s plan.3 This provides you with more flexibility for choosing investments.

These are just some of the advantages of 529 Plans. Working with a financial advisor can help you evaluate the best approach to saving for college.

To read more about the above-mentioned tax advantages as well as some additional tax advantages, please see “Top 10 Tax Facts for 529 Savings Plans in 2019.”4

 

Sources:
  1. USNews
  2. SmartAsset
  3. Saving for College
  4. ThinkAdvisor

 



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