529 Plans That Optimize Financial Assistance For College

Mar 23, 2023 By Kelly Walker

A 529 plan strategy that makes the most available financial help is more critical than ever. Saving money in a bank account will only help if you're trying to prepare financially for your child's college education.

To keep up with inflation, you'll need to invest in it. Five hundred twenty-nine plans are popular because they offer tax benefits and allow contributions to grow for future school costs. This can be a wise choice, but the beneficiary's ultimate use of the 529 funds could be just as significant.

As we all know, higher education is costly. Everyone who has attended college or is putting money down for college knows this. Yet, they could be unaware of the rate at which prices are increasing.

As a general rule of thumb, public university tuition often rises by 2% every year. 1 It equates to an annual price increase of at least 5%.

529 Plans: When and How To Use The Money

To maximize the likelihood of receiving financial help in years three and four of college, a writer suggested using a family's 529 savings plan money in those years. That is if the parents anticipate a year of high expenses and little income.

To verify our findings, we consulted with industry professionals. Given the wide diversity of perspectives we encountered, it is evident that families seeking guidance on paying for college should seek the assistance of a professional.

Gretchen Cliburn, CFP, director at BKD Financial Advisors, says that while it might not make sense for every family, draining the 529 accounts first might make sense.

But if you anticipate loan qualification issues in the future, you shouldn't. Joseph Orsolini of College Aid Partners warns against using your 529 money in the first two years of college. Budgeting for all four years of college is essential for families to decide how to allocate their income, savings, and loans.

He warns that many families make the mistake of spending down their 529 rescues in the first few years, only to find themselves unable to borrow in the latter years. There are no longer any means for these students to complete their degrees.

Consider The Federal Tax Credit

If you spend $4,000 on education-related expenses (including tuition, fees, textbooks, and other course materials), you may be eligible for a $2,500 tax credit under the American Opportunity Tax Credit. Yet it decreases with higher incomes.

Also, you must utilize a different qualified higher education cost to qualify for a tax-free payout from a 529 plan and the same Roth IRA. This is after accounting for the 10% tax penalty and ordinary income taxes on non-qualified distributions.

Prioritizing $4,000 in cash or loans for tuition and textbook costs is recommended by financial experts before relying on the 529 plan. It's best to use the money as soon as feasible. Money saved in a 529 plan is calculated as parental assets, and 5.64% of parental assets are included in the calculation of the estimated family contribution on the FAFSA each year.

Amendments To The 529 Plan Regulations

In addition, there were essential modifications to 529 plans enacted by the Tax Cuts and Jobs Act (TCJA) in 2017 and the Setting Every Community Up for Retirement Enhancement Act of 2019.

Account holders can now utilize their 529 plans to cover the cost of their children's or grandchildren's education from kindergarten through high school at any qualifying public, private, or religious institution.

These distributions will be completely free of federal and, in many instances, state income taxes. This means you may start spending money from a 529 plan long before your child enrols in college.

In December 2019, President Trump signed the SECURE Act into law, allowing the use of 529 plans to repay a portion of student loans. In the past, borrowing money to pay for college wasn't deductible or eligible for tax-free withdrawals.

The new regulations allow plan members to make tax-free withdrawals from their 529 plans up to a lifetime maximum of $10,000 to apply against the principal of eligible higher education loans. The sibling or siblings of the recipient are also eligible to receive $10,000.

The Bottom Line

There are a lot of unknowns, as is the case with many financial matters, but in general, our experts advise not use all of your 529 funds on future financial aid. They do admit, though, that the approach might mean a financial gain for certain people.

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