Opinion: Best practices when saving for college

Kenny Gott

College for you or a loved one will likely be among the biggest expenses of your life. A mountain of student loan debt right out of college can be a daunting long-term problem, and inflation on college tuition has been historically higher than typical inflation for many periods, making it difficult to keep up.

The key to this or any savings goal is to start as early as possible. And while socking away cash in a bank account might do the trick, there’s another option which provides significant growth and tax advantages: the 529 college savings plan. While there are other older tax-advantaged programs for college savings, none are as flexible as the 529. It can even be used for K-12 public schooling, private schools, religious schools and even vocational education. 

A 529 college savings plan lets you invest on an after-tax basis. So, no federal tax deduction. But, the growth is not just tax deferred, it’s federal tax-free as long as the money is spent on qualified education expenses. And in Missouri, you’re allowed up to an $8,000 Missouri tax deduction, or $16,000 for a married couple filing jointly.

Qualified school expenses include tuition, books, class-related fees, and room and board. Visit IRS.gov for an updated list or MissouriMost.org for Missouri’s version. You can find all the rules there, and investment options including efficient low-cost index funds.

529’s are structured within each state and terms vary. Other states’ tax laws may not provide for a state tax break like Missouri does; and some states give you a tax break even if you use a plan from another state. There is no upper income limit for parents, or anyone else, to be able to contribute. However, there is an annual limit on contributions from any individual or couple before gift tax becomes a potential issue. This year the limit is $18,000 per giver. So, for example, a married couple could contribute up to $36,000 this year to a 529 college savings plan account for a student, without having to report the gift. In fact, you could contribute the same amount to any number of other students as well.

For anything beyond that dollar amount per student, your contributions must be reported to the IRS and will apply toward the lifetime gift tax exclusion. That lifetime exclusion is a whopping $13.6 million per individual right now, or $27.22 million for a married couple. So, do report gifts over $18,000, but you won’t owe tax until you hit that multimillion lifetime number. Seek professional tax advice, and always keep school expense receipts on file in case of a tax audit.

For 529 accounts held by parents, the funds count toward the expected family contribution, or EFC, calculation when your student applies for federal financial aid, but the weight applied to it is significantly lower than most other types of savings. A 529 plan account held by a nonparent is not considered for EFC calculations, but distributions are considered a form of income for the beneficiary student and may adversely affect student aid the following year.

You must name a beneficiary (student) for the account, but that can be changed to another beneficiary any time.

If it will be a long time before the funds are used, consider an aggressive stock market mix for max growth potential; when college is within five years or so, gradually reallocate to more conservative investments to help protect against market downturns.

If there are 529 funds remaining after graduation, you can transfer up to $35,000 into a Roth individual retirement account for the student, to get a head start on retirement savings. Now that’s flexible!

Finally, be sure to let grandparents and other interested family and friends know they’re welcome to contribute as well – it makes a great gift for any occasion.

Certified financial planner Kenny Gott is president at Piatchek & Associates and author of the book “Bottom Line Financial Planning.” He can be reached at kgott@pfinancial.com.