MMM Newsletter and Website Header 10.2.15

From Charles Schwab & Co., Inc.

Just because you’ve researched the right 529 college savings plans for your children — and funded them appropriately — doesn’t mean your job is done. Not quite yet. Saving for a child’s college education is never easy. Still, 529 college savings plans offer an excellent option: These investment vehicles are expressly designed to cover higher-education expenses with the potential for tax-deferred growth and tax-free qualified distributions. In addition, many states offer tax benefits for contributions to their plan. Although you’re not restricted to your own state’s plan, you should consider the tax benefits provided by your state before investing in another’s.

But 529 plans don’t guarantee that you’ll save enough to pay for tuition by the time the first bill comes due. They still require careful management between the time when you set them up and decide your contribution rate and begin to pay tuition. You can help protect your savings by avoiding these five common 529 mistakes:

Mistake #1: Assuming your money will grow

A 529 plan might be called a college savings account, but don’t let the word “savings” fool you. Unlike a bank savings account, it generally isn’t federally insured. It’s an investment account. Your investments aren’t guaranteed to grow, and their performance depends on your selections, as well as market conditions. People can, and do, lose money in 529 plans. You can mitigate the risks by starting a 529 plan early so that you have more time to recover from any market losses.

Mistake #2: Forgetting to adjust your asset allocation and savings rate

When you shop for a 529 plan, you have the option of choosing an age-based strategy or a static one. An age-based portfolio holds more stocks than bonds initially and grows more conservative over time (like a target-date fund).

The static option, where you choose the investments, sticks to the mix of assets you pick. If you go with this option, bear in mind that you’re responsible for periodic rebalancing, and for adjusting the asset allocation over time. As with many investment goals, the standard advice here is to reduce your equity stake as you near your goal.

Also, it’s not a bad idea to increase your annual contribution rate every year by, say, a base of 2% to take into account the effect of inflation.

Mistake #3: Getting the timing of your contributions wrong

Contributions to 529 plans must be made by December 31 to have them count toward the current year for gift tax purposes. This differs from tax-advantaged retirement savings accounts like IRAs, for which you typically have until mid-April of the following year to contribute for income tax purposes. However, if your in-state 529 plan offers a state income tax deduction, the April 15 deadline might apply in that case.

The December 31 deadline is important to keep in mind if you want to claim state tax benefits. The same goes for the federal $14,000 gift tax exclusion, though any overages can be applied against your $5.43 million lifetime gift exemption. Keep in mind that in the year you exceed the gift tax threshold, you must also file a gift tax return. See the instructions to Form 709 for more information.

Mistake #4: Getting the timing of your withdrawals wrong

Once your child has begun college and the bills start rolling in, be careful to take out only the money you will use for qualified college expenses within that calendar year. Also, make sure the expenses you intend to claim are on the IRS-approved list of qualified expenses for 529 plans, and aren’t already covered by other tax-advantaged sources like scholarships.

Mistake #5: Emptying an account when your child doesn’t need the money

Speaking of scholarships, what if your child ends up winning a full or partial free ride to college? In that case, you can withdraw the exact amount of the scholarship, and the usual 10% penalty on nonqualified distributions would be waived. The remainder in the account can be used for other qualified expenses that aren’t covered by the scholarship.

What if your child decides to attend a foreign institution where you can’t apply 529 funds tax-free? You’ll have to pay taxes and the 10% penalty on earnings, plus state income taxes (if you took that deduction).

You have other options before you resign yourself to taxes and penalties, however. If your child intends to pursue an advanced degree, you could leave the money in the plan where it will continue to have tax-deferred growth potential and can later be used to help pay for graduate school.

Or, if you have other children, you could make them the beneficiaries of the funds without paying any penalty or tax. Just be sure to make the switch before the next child begins college.

A third option is to designate yourself the beneficiary and apply the funds to your own continuing education courses. You can also wait and designate the funds for your grandchildren.


About LRPC’s Monday Morning Minute

Lawton Retirement Plan Consultants, LLC (LRPC’s) Monday Morning Minute is crafted to provide decision-maker’s with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC

Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or or visit the firm’s website at Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.