Limited 529 Plan Knowledge Holds Savers (and Advisers) Back

Educating people about the plans is important, as a recent Edward Jones survey found that only 29% of Americans know what the purpose of these plans are.

Art by Cristina Spanò


While investment firms that service 529 college savings plans say they have been growing in popularity, a recent survey conducted by The Harris Poll on behalf of TD Ameritrade found a lack of knowledge about the plans.

Only 32% of people know that withdrawals from 529 plans for qualified educational purposes are tax free, and only about half know that the funds can be used for expenses other than tuition. Only 59% know the funds can cover textbooks. Just 48% know it can cover school supplies, and only 51% know it can cover housing.

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Educating people about the plans is important, as a recent Edward Jones survey found that only 29% of Americans know what the purpose of these plans are, says Russ Tipper, senior vice president at Capital Group, home of American Funds.

“They should be an important part of advisers’ practices, since, after retirement, saving for a child’s college education is often the second priority for clients,” Tipper says. “Americans are increasingly concerned about growing student loan debt, and the problem will only exacerbate with the cost of higher education continually increasing.”

When establishing a 529 college savings account, a parent should first consider purchasing one offered in their state, as 34 states and the District of Columbia allow either a full or partial deduction of contributions from their state taxes, says James Sullivan, vice president at Essex Financial.

The most attractive feature of 529 plans is that the money grows tax free and withdrawals are not taxed if they are used for a qualified educational expense, Sullivan says. Those withdrawals are federally tax exempt and almost always state tax exempt, he says.

Qualified expenses include not just tuition but also room and board and school supplies, Tipper says. The funds can also be used for K-12 private school tuition or for classes to learn a new skill, Sullivan says.

If the money is used for K-12 private education, parents can only withdraw $10,000 a year, but there is no limit on what can be withdrawn for a college expense, Sullivan says. In terms of how much parents can contribute a year, each parent can contribute $15,000 a year, and the plans even allow for parents to front-load five years’ worth of contributions, meaning that would be a contribution of $75,000 per parent, or $150,000 for a couple, he says.

However, states do have contribution caps, Tipper says. American Funds runs a number of 529 college savings plans, and the states sponsoring them have contribution caps ranging from $150,000 to $250,000, he says.

In addition, anyone can contribute to the 529 plan, so a parent can tell their friends and family about its existence and potentially receive help with funding the plan, says Mike Lynch, vice president, strategic markets, at Hartford Funds.

Another benefit of 529 college savings plans over custodial accounts is that parents are always in charge on the money, Sullivan says, whereas in a custodial account, when the child turns 18, they can direct how the money is used. “And while the money is counted as a parental asset, it impacts financial aid much less than if the assets were in the kid’s name,” he says.

However, the year following the first year that 529 assets are used, if they are owned by someone other than the parent, such as a grandparent or uncle, their use is counted as a child’s asset, Sullivan says. “One way around that is using the 529 funds in the junior or senior year, so that they do not negate financial aid,” he says. And another point to consider is that 529 plans cannot be jointly owned by parents, so if a couple gets divorced, the ex-spouse in charge of the funds may not use them as intended, Sullivan says.

Should a child decide not to go to college, the funds can be used for another child or even a grandchild, so 529 plans offer a lot of flexibility, Sullivan says. If the funds are not used for educational purposes, the principal contributions won’t be taxed, but the earnings will be subject to both federal and state taxes, plus a 10% penalty, he says.

That is why, says Matt Rogers, director of financial planning at eMoney Advisor, parents considering a 529 plan should be “reasonably sure their child will be attending college.”

The states also offer investment options with glide paths much like target-date funds, Rogers says. As the child approaches college, the equity exposure is dialed down while the bond exposure increases, he says. The preset glide path is also a good feature, as 529 plans limit trades that account owners can make to only two a year, Tipper says.

Finally, if a child receives a scholarship from a college, a parent can withdraw whatever that amount is from their 529 plan and be charged federal and state taxes, but not the 10% penalty, Sullivan says.

What to Expect With Unexpected Early Retirement

Considerations for participants when retirement comes earlier than anticipated.

Art by Suharu Ogawa

Many workers anticipate retiring at or around age 65, when retirement traditionally begins. Some believe they will work longer than that, and others shorter.

Importantly, research shows the timing of when many people enter retirement is not completely in their own control. In a recent survey conducted by NerdWallet, the company found more than one-third of American retirees said it was not their personal choice to leave the workforce. While the number is less than half of respondents, it still represents a sizable portion of participants forced to retire due to unforeseen circumstances.

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According to NerdWallet, 18% had to leave because their health negatively impacted their ability to work, while 9% simply lost their job and could not find another. Not explored as a reason in the survey but also another issue is leaving the workforce to care for a loved one battling physical or mental illness, whether it’s a family member, significant other, or a child.

“Illness can be debilitating, not just for the person who gets sick, but on the primary partner of that person, too,” says Harris Nydick, founding partner and managing member of CFS Investment Advisory Services. “It’s difficult to keep a career going and trying to keep your spouse or a significant other going too.”

Considerations in Early Retirement

If a worker finds themselves needing to take retirement early on, there are concerns to understand going forward. The first is how to best begin withdrawing savings from a 401(k) or individual retirement account (IRA). If participants younger than 59 1/2 draw from these tax-qualified savings accounts without meeting certain disability requirements or obtaining another exception, there will be an automatic 10% penalty tax assessed on top of any normal income taxes.  

Another matter is how to best time Social Security. Delaying these checks until age 67 is often ideal, as workers will lose a percentage of their benefit each year it is claimed earlier. If an individual begins making their claims at age 62, generally the earliest eligible age to begin taking Social Security, this can result in substantially reduced benefits—with monthly payments falling by as much as 30%, according to the Social Security Administration. If participants delay their claim however, their benefits will increase 8% a year until age 70, says Arielle O’Shea, investing and retirement specialist at NerdWallet.

“It pays, quite literally, to delay taking your benefits,” she recommends. “But, if you’re forced into early retirement and you have no other way to make ends meet, early claiming of Social Security is an option.”

One tip O’Shea adds is if participants do end up back on their feet or no longer need to claim Social Security after taking a reduced benefit early, they can suspend the benefit once they reach age 67 until age 70. Doing this can increase their checks by 8%.

Another matter is the issue of maintaining health insurance coverage. Some generous employers may offer continuing coverage until Medicare eligibility, depending on the terms of the employees’ separation. But unfortunately many will not, or they may only provide coverage for a relatively short period.

If a retiree is the caregiver for a loved one, the cost of private health insurance with restricted savings is almost unattainable, says Nydick. Taking on part-time work, or moving towards contracting or consulting gigs, can assist with health insurance and even bring money to the household. Nydick mentions how some companies, such as Starbucks and Costco, offer health insurance and offer 401(k) benefits for part-time workers. Even if one does not generate as much income as they did in their established career, this path minimizes out-of-pocket costs.

If part-time work is not feasible, freelancing and consulting can generate substantial income while working from home or remotely, says Nydick. “If you can’t leave home, maybe you have the kind of skill set that allows you to have a consulting job, where most of your work is done via email, Zoom or Go-To Meeting,” he adds.

Conserving Can Make a Difference

As one would expect, O’Shea recommends early retirees take conservative approaches when withdrawing for their retirement accounts. This means more modest vacations and spending habits.

“Early retirees have to set a new budget,” Nydick advises. “Setting a new budget and setting new expectations are all things these people have to consider.”

“It can make sense to meet with a financial planner, but early retirees can also use a retirement withdrawal calculator to get a good estimate of how much they can spend annually,” O’Shea says.

Also important is investing savings appropriately. If a worker retires at age 60, they may still have 30 to 35 years of retirement in front of them, O’Shea notes. They will likely need to maintain some exposure to equity markets, if only to outpace inflation. Consulting a financial planner, or even a robo-adviser—which typically costs less than a planner and can still manage investments—is ideal.

“This might mean keeping a couple years’ worth of expenses in liquid accounts so you’re covered in the case of a market downturn, but investing the rest of your savings in a portfolio of stocks and bonds, heavily tilted toward the stock allocation,” O’Shea suggests.

Along with conserving money are coordinating personal budgets. Considering debt and income, these new retirees will have to arrange a new plan until additional benefits or money is set in.

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