529 Plans – What’s to Know Beyond the Basics?

Staying focused on long-term financial goals is key to investing success, especially when we are weathering periods of market volatility like the present. If you are in a position to help your children or grandchildren pay for college or graduate school, or if you can anticipate a future day when a family member will benefit from your foresight, it is always a good time to consider a 529.

Most of us know that 529’s enable us to save for higher education with the benefit of tax-free growth. Less well understood are important estate-planning applications and how to select the right plan from the proliferation of local and out-of-state options. We invite you to head back to school for a few minutes to review the basics and some attractive subtleties of 529 programs.

We’d also like to take this opportunity to advise those of you with Vermont 529 plans that you may have some homework to do related to recent changes.

Giving, with Flexibility

We recommend consideration of 529 plans, not only as a means to save for college, but also as part of gift and estate planning. Contributions are no longer included in the donor’s taxable estate at the time they are made but, importantly, the donor can remain the owner of the 529 plan, thereby retaining control over investment options and distributions. Unique relative to other wealth transfer vehicles, the owner may also reclaim the account at any time by paying taxes on the appreciation plus a relatively small penalty.

It is also possible to change the beneficiary to another qualifying family member in the event of excess or unused funds, which could extend the life of the account to the next generation. While the program is remarkably flexible, each state has its own rules, including account value thresholds that can limit further contributions (a nice problem to have!).

Some Taxation Basics

The most popular version of 529 plans, known as a college savings plan, does not require withdrawals to occur within any specified timeframe. When used for qualified education expenses (including tuition, books, room and board), earnings in 529 plans are not subject to federal, and often state, taxation.

Contributions are subject to gift tax rules that generally limit giving between each donor and beneficiary to $14,000 per year ($28,000 for married contributors, however, there are special circumstances where 529 plans can be prefunded by as much as five years).

Contributions are made with cash, and are not deductible at the federal level – but many states do offer incentives. In Vermont for example, a taxpayer is eligible for a state tax credit of 10% of the first $2,500 contributed per beneficiary per year, provided the money is invested in a Vermont-sponsored 529 plan. Spouses can each make a contribution for a given child, doubling the benefit. Thus, a Vermont couple contributing a total of $10,000 for two children can expect to shave a not insignificant $1,000 off their state tax bill per year.

Comparison Shopping

How does one choose a 529 plan? Nearly all 50 states have at least one plan and there is no requirement that you invest in your own state’s plan or the plan of the state where the beneficiary ultimately goes to school. The single best resource we’ve found for comparing and contrasting the various 529 plans is Here are some factors to consider:

Tax credits – if you live in a state like Vermont where your contribution qualifies you for a tax credit on your state return, you will probably want to go with one of your in-state options – it is unlikely that any other plans’ attributes will be as compelling as the savings you’ll realize.

Fees – these come in several forms and should be considered in the aggregate to get a full picture: advisor commissions (for plans sold by brokers, only relevant in some states), asset-based fees for management and administration, and underlying investment fees.

Investment options – investment performance will be an important determinant of the ultimate benefit derived from a 529 plan so it’s important to carefully weigh the investment options that may include actively managed stock and bond funds, passive vehicles, and age-based funds that anticipate when the beneficiary will be heading off for college.

Vermont 529 Plan Owners – Homework!

Recently, those of us with Vermont 529’s received notification of a pending change in the plan manager and new investment options, effective September 14, 2015. Account balances will transfer automatically without any action required on your part. However, you will need to re-register for online access and to re-establish payroll deductions and/or automatic contributions from your bank account on or after September 15. While not a cause for concern, this is indeed a good excuse to review investment allocations, savings objectives and the merits of topping off accounts in the current tax year. If you have misplaced the welcome package sent to your home, it can be found here.