5 reasons to gift a college saving plan contribution

For years, I can remember getting holiday and birthday gifts I didn’t ask for and certainly didn’t need.

Had college savings programs existed when I was growing up, I would’ve relished contributions to what we now call 529 Plans, which are offered by every state.

I know this sounds like a cliché, but 529 plan contributions truly are gifts that keep on giving. A decent education will pay you back the rest of your life. A video game, TV or clothing will be gone in a few years.

You can put college plan contributions on your shopping list for college-age children, but you can also sock away money for yourself, spouse or other relatives. The beauty of a 529 plan is you can easily change beneficiaries or even set up a plan for yourself or partner.

Here are five solid reasons for investing in a 529 plan this holiday season:

529 plans have great tax benefits. Although contributions are aftertax, the earnings within a plan are tax-free. Many states give you small write-offs if you contribute, but you need to be a resident. Some 33 states and the District of Columbia offer a state tax break. The only catch is that you’ll be taxed if you use withdrawals for non-college expenses.

Assets in 529 plans won’t unduly hurt financial aid prospects. Since the funds are in the parents’ names, a student’s aid chances aren’t diminished much at all.When a school calculates the student’s Expected Family Contribution (EFC),” according to SavingforCollege.com, “only a maximum of 5.64 percent of parental assets are counted. This is quite favorable compared to other student assets, which are counted at 20 percent. Higher EFC means less financial aid.” 

You can target specific colleges and obtain tuition discounts. These so-called prepaid plans allow you lock in today’s tuition rates. “Typically, an account owner will purchase somewhere between one and four years of tuition for a young child, and when that child reaches college age, the plan pays out based on tuition rates at that time,” according to collegesavings.org. If you’re worried about college price inflation, which has been outpacing consumer inflation in recent years -- and you have a college in mind -- this is a good vehicle. 

Contributions are useful in estate planning. A shout-out to grandparents:Your contribution qualifies for the $14,000 annual gift tax exclusion, so most people can make fairly large contributions without incurring the gift tax,” notes SavingforCollege.com. “Even better news is that if you make a contribution of between $14,000 and $70,000 for a beneficiary, you can elect to treat the contribution as made over a five calendar-year period for gift tax purposes.”

You don’t have to be a good investor. All plans offer “age-based” or “risk-adjusted” portfolios. That means professional managers select mutual funds for you and reduce stock- and bond-market risk the older the child gets. 

What if you want to go to graduate school and have no children? Save in a 529 plan. As long as the withdrawals are used for college-related expenses, you won’t be taxed on them.

And don’t worry about contribution or age limits. Contribution limits, which vary by state, range up to $500,000, and there are no age limits on who can contribute. 

When shopping for a 529 plan, keep in mind that you can choose from any state’s offering, although check your home state first. As noted above, many offer tax breaks for investing.

Also note that the lowest-cost plans are “direct-sold” programs, which don’t charge a commission and have lower expenses than adviser-sold plans. You don’t need to invest in a 529 plan through a financial adviser. 

If you choose to shop around among state plans, check the ratings on the best plans. Ideally, they have low expenses and steady returns. Both Morningstar and SavingforCollege.com provide annual rankings.

It makes sense to tally your state write-offs -- if offered -- against highly ranked out-of-state plans. To ensure that you’re comparing similar programs, look at total expenses for direct-sold, age-adjusted or individual funds.

Need some more convincing that a 529 contribution is better than the latest cool toy? Run some numbers to see how much you’ll need to save.

For example, say you have a 10-year-old child now. If you want to cover the entire cost of that child’s education when he’s 18, you’ll need to save more than $145,000. But if you break it down, that’s $848 a month.

What if you haven’t saved much of anything and your child is in high school? Look at the wide range of scholarships and grants available. A host of online tools will help you search for financial aid. 

Even better, make college savings a year-round family affair. Instead of gifts, ask grandparents and other relatives to make cash contributions to 529 plans. In their own way, these gifts will ensure that future holidays will be much less financially stressful. A debt-free degree is always a superb gift. 

  • John Wasik

    John Wasik is the author of The Debt-Free Degree and 15 other books. He writes and speaks regularly on personal finance issues throughout North America.