Baron Financial Team Answers Questions About
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Presented by Nicholas Scheibner, CFP®
View or listen to our video for answers to some frequently asked questions about 529 plans:
Nick Scheibner, Wealth Management Advisor at Baron Financial Group, answers some of the most frequently asked questions about 529 plans.
What is a 529 plan?
A 529 plan is also known as a qualified tuition plan. It is simply a financial account, with the goal being to provide tax-free investment growth when the money is used for qualified educational expenses.
So, you're prepaying college costs with the hope that you're getting tax-free investment growth that is different than other types of financial accounts.
Now, qualified educational expenses can be tuition. It can be books. And even as of this recording, you can use it for some K through 12 private school tuition. But the main purpose is for that tax-free growth.
What is the difference between a 529 plan versus a custodial account?
A custodial account is a financial account that you opened with a minor child being named on the account. Neither account is either better or worse. It's just what would you like those funds to be able to do? And the tax treatment for those funds are different.
So, the first piece - what provides tax-free investment growth?
A 529 plan provides tax-free investment growth, but only when used for qualified educational expenses. That same money in a custodial account, when those investments are sold, will be taxed at capital-gains rates.
The account owner for a 529 plan can remain constant. For a custodial account, the minor, typically a child, becomes the account owner upon the custodial age. Some states it's 18. Some states it's 21.
Now, the investment choices typically in a 529 plan are very limited to the plan options. A custodial account is unlimited to your investment custodian. There are penalties if you use the money in a 529 plan for non-qualified educational expenses. For a custodial account, there are no penalties. You have much more flexibility with expenses for a custodial account.
When it comes to financial aid - a 529 plan is usually seen more favorably on the FAFSA form and is considered a parent's asset. When money is transferred to a child's own name, it's considered a child's asset, so it can have a more negative effect on financial aid.
But you really need to determine why are you putting money into an investment account. And what is the purpose? What are you hoping for that child or grandchild to be able to do? If it's to save for college, a 529 plan makes more sense. If it's for flexibility to either buy a car or put a down payment on a house, travel, or just general gifting, maybe a custodial account is better.
But neither one is better or worse. It just depends on what you're looking to do with the funds.
What 529 plan should you choose?
Well, the first question to ask is, do I get a state-income- tax deduction if I contribute to my own state of residency’s 529 plan. If the answer is yes, then typically you'll want to choose a plan that is based out of your state of residency.
However, if the answer is no, or if having a state-income- tax deduction would have no effect on your overall finances, then you have the full universe of 529 plans throughout the whole country to choose from.
What if you don't use the 529 plan money for college?
Well, it's still there for you or your beneficiaries. However, if you take a withdrawal from a 529 plan and that withdrawal is a non-qualified withdrawal, then what's going to happen is at the end of the year, you're going to get a 1099 Q from your 529 plan administrator, and it'll tell you how much has been withdrawn from the account and also what portion of that withdrawal is earnings-based and the portion of earnings on that withdrawal will be taxable and also have a 10 percent penalty.
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Disclosure: This is a general communication being provided for informational purposes only. Every investment strategy has the potential for profit or loss. This material is not intended to be relied upon as a forecast, research, tax or investment advice.