SHANE TENNY: Saving for college is one of the most common goals that parents have for their children. And college is expensive and getting more so every day. And families with good incomes often have less favorable financial aid options, but they have the ability to save, to help cover the costs.
For about the last 20 years, since 1996, the 529 has been the most popular savings vehicle for college. It comes from section 529 of the Internal Revenue Code. The plans have a lot of flexibility and tax benefits, which makes them really attractive. But there's also so many options now that they can feel confusing. So we wanted to take some time and just try to clear up a few of the most common misunderstandings that we hear.
The first is 529 plans are sponsored by individual states. In fact, some states offer more than one variety of savings plan like Florida. However, you are not required to use the plan from the state you live in. Some states offer tax incentives to the residents of that state to use their own plan. But the markets are really competitive, and you may find that another state's plan suits you better for one reason or another.
Also, no matter which 529 plan you use, in most cases the proceeds could be used at any college or university or vocational school that's eligible to participate in the student aid program administered by the Department of Education. So for example, if you live in Texas it's perfectly okay to use the 529 plan from, say, Virginia. Even if your kid ends up going to school in Florida. Makes sense. So what's the main advantage of 529 plans?
Well, the main advantage is this, the contributions you put in can be invested in a variety of options within the plan based on your goals and timeframe and comfort with market volatility. And any growth is not subject to federal tax and generally not even state tax when it's used for qualified educational expenses like tuition, room and board, books, and fees. And unlike other types of accounts that provide tax-free withdrawals, there's no income restriction on who can set up a 529 or contribute to them. So they're a perfect option for high-income families like physicians and dentists.
Now, one of the main questions that we hear from clients is, what if my child ends up getting a scholarship? Well, if your child ends up getting a scholarship, first of all, congratulations. You might not need all the money you've saved in your 529 plan. And so you generally have three options. The first is just to leave the money there for some future use by your child, perhaps for graduate school.
The second option is you could direct it to another family member, like a sibling or even a future grandchild. And the third option is to actually withdraw the funds. The earnings in your account will be subject to income tax, either on your return or your child's. Normally, there would also be a 10% additional federal tax on the earnings portion, which is the penalty for a non-qualified withdrawal. But the penalty is waived when a scholarship is the reason for the withdrawal.
So in effect, your tax-free 529 Investment has been turned into a tax-deferred investment thanks to the scholarship. Anyway, most scholarships don't cover all the expenses of college, and so you'd still be able to use the 529 on other things like technology fees, books, room and board, things like that.
Obviously, there are a lot of details around 529 accounts. And so if you have more questions, feel free to give us a call. Or you can always go to the IRS website and search for publication 970. It's tax benefits for education. I hope this was helpful and hope to hear from you soon.
For over 50 years, Spaugh Dameron Tenny has provided comprehensive financial planning for physicians and dentists across the U.S. In addition to providing personalized advice, we walk our clients through their options to help maximize finances and maintain financial security.
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