Are Tax Savings of 529 Plan Worth It?

The number one question I get from clients about college funding is whether or not to make contributions to 529 Plan accounts. People are interested in their tax savings, but are hesitant about possible tax and penalties later if they don’t use the funds for qualifying college expenses.

The Case Study from our recently released College Funding for the Working Wealthy white paper clearly illustrates qualified tuition

programs such as 529 plans and Coverdell ESA accounts provide superior after-tax returns for Working Wealthy households. In fact, the 529 is one of the rare tax breaks that is still available for higher income households that typically are not allowed deductions and credits due to phase-out rules.

Tax advantaged savings from qualified tuition programs like 529 plans can add up over time, especially for households with higher income levels subject to the higher 20% long-term capital gains rate and additional 3.8% on investment earnings. The example case study in our white paper showed the couple would save almost $27,000 in taxes over eighteen years when using a state-sponsored 529 plan versus a taxable brokerage account. The savings come from being able to deduct contributions on your state income tax return (if allowed in your state) and avoiding the taxes on earnings in a brokerage account.

Most 529 plans allow you to complete the enrollment form online in less than five minutes. You may set up electronic transfer with your bank account for automatic contributions or manually initiate them at specific times during the year. The investment funds available tend to be pre-packaged risk or age-based model portfolios and Iowa’s 529 College Savings Plan investment performance is adequate.

The one major disadvantage of the 529 Plan account is the potential tax and 10% penalty on earnings withdrawn for non-qualifying college expenses. But, a little planning can help mitigate that risk down the road. Contact our office to learn more.