Parents often have many questions about 529 Plans – what they are, how to use them, what their benefits are. We’ve covered all those topics in other posts here, but have not gone over some of the myths of the plans themselves. Here we outline five of the most popular myths of a 529 plan.
1. The Impact of 529 Plans on Financial Aid
The Expected Family Contribution or EFC dictates the amount of financial aid a student will receive. The EFC is determined each school year by the federal government when filling out FAFSA. EFC is calculated by considering a student’s and parent’s financial assets and income. Typically, parental assets are counted up to 6% while a students is counted up to 20%. Typically, the most common assets for families to report include: money in cash, savings, and checking accounts, businesses and other investments in stocks or real estate. The great thing about 529 plans is that the money in those plans is labeled under parental assets. Furthermore, as long as the plan is owned by the parent or student, distributions are not required to be reported as income on the FAFSA application. Keep in mind though that distributions will be treated as untaxed income for the beneficiary, and must be reported as student assets for FAFSA.
2. 529 Plans are Controlled by the Beneficiary
Depending on whether the parents, grandparents, or any other relatives or guardians set up the account, the money is under their control. The beneficiary cannot withdraw funds from the 529 plan to use for, say, a lavish vacation, new car, or video games. This is one of the differences between 529 Plans and other custodial accounts which sometimes grant the beneficiary control of the funds once they reach legal age. If, in the event that a beneficiary chooses not to go to college or suffers a life changing incident, the account owners have a few options on what to do with the money in the account. First, they can earmark the funds for some future use for that child, such as gradschool. The second is to assign a new beneficiary in the family such as a sibling or future grandchild. Finally, the third option is to withdraw the funds, however, the withdraw may be subject to penalty taxes.
3. A 529 Plan is Limited to the State It’s Opened In
Just because a 529 Plan was opened up in New York does not mean it can’t be used for college in California. Although resident’s often see state tax benefits, should you decide to use another state’s plan, you may be able to reap federal tax benefits instead.
4. 529 Plans Can Only be Used for College
Should your child decide that college is not in their best interest, you can pass the plan onto another beneficiary or even use it for yourself! If the funds are used for an unqualified expense, you will face a 10% penalty on the earnings portion and owe federal and state income taxes.
5. 529 Plans and Penalties
In the event that your future grad is awarded a scholarship, a special exception may be applied to the penalty tax rule. The penalty tax applies when money in a 529 Plan is withdrawn for nonqualified expenses. These can include things like transportation costs, gym memberships and a cellphone plan. To learn more, head on over to our blog post here about 529 Plans. If a beneficiary receives a scholarship, employer education assistance or another type of educational aid the penalty may be waived. However, although the penalty may be dismissed, you will still have to pay income taxes on the withdrawal you made.
All in all, a 529 Plan, especially one taken with U-Nest, offers a fantastic way for families to save for college. The pros of the plan outweigh the cons, and the concerns that most parents have with the plans can be avoided or planned around.
If you’d like to learn more about the amazing benefits of 529 Plans, visit our blog at www.u-nest.com
This material is for informational purposes only and should not be construed as financial, legal, or tax advice. You should consult your own financial, legal, and tax advisors before engaging in any transaction. Information, including hypothetical projections of finances, may not take into account taxes, commissions, or other factors which may significantly affect potential outcomes. This material should not be considered an offer or recommendation to buy or sell a security. While information and sources are believed to be accurate, UNest does not guarantee the accuracy or completeness of any information or source provided herein and is under no obligation to update this information.