College is still worth the cost— research has found that the average return on investment for a four-year college degree sits at about 14-15%. That's a higher return expectation than most traditional investments can offer, and it means that workers with bachelor's degrees earn an average of USD 1million more than high school graduates over the course of their careers! Even still, that doesn't make it any easier to come up with the funds to pay the admittedly frighteningly high price tag of tuition.
However, thanks to two key tax benefits, 529 college savings plans can help reduce the overall cost of education. First, contributions are tax-deductible, or come with tax credits, in over 30 states. Second, 529 investment earnings grow tax-free and distributions aren't taxed if they're used for qualified education expenses. That's an important feature because the benefits of tax-free growth compound over time; a USD 100 contribution, invested for 20 years at a 5% annualized return, would give you about USD 265 in a 529 account, 17% more than the USD 226 in an account paying a 23.8% capital gains tax at the end. The benefit could be even higher due to lower tax drag and any state-level tax deduction or credit.
Which distributions are "qualified"?
According to the IRS guidance, 529 college savings plans aren't just for college! The general guidelines are tuition, fees, books, and room & board at eligible education institutions. Computer technology, equipment, or service costs can also qualify as long as they are used while the plan beneficiary is enrolled at the eligible education institution. Additionally, families can use up to USD 10,000 per year for tuition at elementary or secondary public, private, or religious schools.
And with the passing of the SECURE Act, principal and interest payments toward qualified higher education loans will now be considered qualified 529 plan expenses, up to the lifetime limit of USD 10,000 per beneficiary and USD 10,000 for each of the beneficiary's siblings.
How much do I need to save? What if I save too much?
529 plans come with lifetime contribution amounts that vary from plan to plan, ranging from USD 235,000 to USD 520,000 per beneficiary. To get the most value out of the tax-free growth, it's best to start early and devote most of the contributions to meeting college costs. But if you want to get the most of the tax deductions or credits offered by your states, you should also consider using contributions to cover the up-to-USD 10,000 costs for K-12 private school expenses.
When estimating how much you plan to spend out your 529 account(s), be sure to incorporate all qualified expenses, and all of the beneficiaries for whom you plan to pay for education (including the as-yet-unborn). Starting with just one 529 account may be a good strategy. A 529 account can have only one beneficiary at a time, but this designation can be changed once a year without tax penalties or consequences.
Read the full blog post Why should I use a 529 plan? 5 May 2020
Main contributor: Ainsley Carbone, Total Wealth Strategist Americas, UBS Financial Services Inc.
Product of the Chief Investment Office