Educating Your Clients on 529 College Savings Accounts

As millions of incoming college freshmen get their first taste of their new surroundings, there’s no better time to remind advisors that not all 529 college savings plans are created equal.

The complex tax treatment attached to 529 plans make IRAs and 401(k) retirement savings plans look like simple arithmetic by comparison.

If nothing else, 529 college savings plans seem to have polarized the financial advisor community into convincing adherents and staunch detractors.

“There's some people with pretty strong opinions about them (529 plans),” said financial advisor Eric J. Dostal with Sontag Advisory in New York City. “Some people like them a lot and some people hate them.”

Advisors agree that 529 plans are powerful tools, but managing those tools isn’t easy, even for veteran advisors.

Not-so-Simple Tax Matters, Simply Stated

More than 30 states, including the District of Columbia, have full or partial state tax deductions for 529 plan contributions, writes Matthew Toner in an August blog post on Savingforcollege.com.

For advisors, untangling those deductions is where the real work begins.

Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania offer a state income tax deduction for contributions to a 529 plan in another state.

California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina have a state income tax, but do not offer a deduction for contributions.

New York, Illinois and New Mexico offer state income tax deduction, but only for those investors who participate in the state 529 plan, Dostal said.

“What I advise clients and other advisors to do is to contribute to the 529 to the extent that a client can get a state tax deduction on the contribution,” said Dostal. “That can be a nice little bit of savings.”

The F-Word: Fees

Fees differ, too, even with two plans based in the same state. Take Pennsylvania, for instance.

The state investment plan, PA 529, allows investors to open an account for as little as $25.

Expense ratios range from 0.36 percent to 0.50 percent depending on the underlying funds, and other account maintenance fees may apply, according to Pennsylvania Treasury disclosure statements.

PA 529 funds are managed by Vanguard Group, the Pennsylvania-based mutual fund complex.

But the PA 529 program is different from The Vanguard 529 College Savings Plan, which is administered by the Board of Trustees of the College Savings Plans of Nevada, a state with no income tax.

Vanguard’s 529 requires $3,000 to open the account, but the expense ratios for age-based portfolios charge as little as 0.17 percent.

Investors in the Vanguard 529 plan also have more than double the investment options compared with PA 529 investors.

Calculating the Effects of Time and Travel

It’s hard to argue with the tax-deferred nature of 529s, but there is a danger of putting too much, or overfunding, a 529, said Patrick Amey, a financial advisor with KHC Wealth Management in Overland Park, Kan.

Not every high school graduate is destined to go to college, and 529 investors with a short time horizon need to be careful about putting too much away in college savings, Amey said.

“There are other things in play when it comes time to pay for tuition, room and board, and you don’t want to exclude yourself from those other deductions,” Amey said.

Money in the 529 plan that isn’t used for educational expenses is taxable as ordinary income, and may even be subject to a penalty.

Other advisors point to Roth IRAs and after-tax savings to reduce the risk of being left with funds in the 529 after graduation.

“What I really enjoy about the Roth IRA is the flexibility it offers over the 529 plan,” writes Scott Hanson, senior partner at Hanson McClain Advisors in Sacramento, Calif.

One issue that consumes some 529 plan advisors is when clients move from one state to another, which happens often.

For clients who move to a state in which the tax advantages are better than in state they were living in, it even makes sense to open a second 529 plan, Amey said.

“Indiana has a great tax credit and if you move from Missouri to Indiana, it makes sense to enroll in the Indiana plan,” he said.

529 Plan Asset Growth Rises by $22 Billion

Assets in 529 plans grew by nearly $22 billion to $275 billion in 2016 over the previous year, the College Savings Plans Network reported in March.

The number of 529 accounts increased 3.2 percent to 13 million accounts at the end of last year over the end of 2015, CSPN also reported.

The average 529 account size increased in 2016 to $21,383 as of December 2016, a 5.9 percent increase since the end of 2015.

Contributions grew to nearly $27 billion in 2016 and more than 54 percent of all 529 account received contributions in 2016, CSPN said.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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