The words “back to school” don’t mean the same thing for everyone—it’s not all sharpened pencils and shiny red apples for the teacher. For many, it means scraping together tuition for college. But, school is a time for personal development (and not financial anxiety), which is where Virginia’s 529 plan comes into play.
Named after section 529 of the Internal Revenue Code, the 529 Savings Plan is designed to help families save for future educational expenses. They can be used to help pay for qualified educational expenses in any state and even at a large number of foreign schools. In Virginia, the two most popular options are: the direct-sold Invest529 and the advisor-sold College America. It is important to note that these are just two options out of many, and they might not be the best for everyone.
The first thing to understand about a 529 plan is that, if used properly, it offers substantial tax advantages. Every state’s 529 offers tax-free investment growth and tax-free distributions, as long as the money is spent on qualified educational expenses. For tax purposes, a contribution to a 529 is seen as a gift, and as such, it is currently capped at $15,000 per person, per year for 2018, before eating into an individual’s lifetime exclusion. However, there is a first-time catchup allowed, equal to an additional five years’ worth of gifts. In other words, an individual can contribute a one-time maximum of $75,000 in 2018 to carry forward for five years.
Virginia residents get the added bonus of a $4,000 unlimited, carry-forward, annual state tax deduction. For example, if you funded a 529 with $40,000 today, you could deduct $4,000 per year from your Virginia state taxes for the next 10 years. Those age 70 and over have the added benefit of being able to deduct the entire amount contributed to a Virginia529 account in a year.
Let’s say that the account is worth $80,000 in 18 years. As long as the money is spent on qualified educational expenses, there would be no taxes owed on the $40,000 of growth.
The last component of a 529 plan is the investment choices. Both the Invest529 and College America plans offer a wide array of well-diversified options. College America is a partnership between the state of Virginia and investment company American Funds. An investor is limited to that fund family if they choose that plan. Invest529, on the other hand, utilizes several different fund families to create strategically allocated portfolios from which an investor can choose.
One more piece of advice: There are several ways for a person to support themselves in college. From loans to jobs, it can be done. There are no such support options for retirement, and Social Security is typically not enough for a person to live happily on. In other words, deciding where to allocate savings is a decision with long-lasting consequences.
David Posner is local investment executive specializing in utilizing socially responsible options for long-term financial goals.