They're tax friendly, flexible and available to anyone. Yet, 529 education savings plans are still underused. Here are five things that parents, grandparents and anyone hoping to get a leg up on college costs need to know.

How are most families saving for college? According to SallieMae’s, How America Saves for College 2018 report, only 30% are using a 529 college savings plan, even though these vehicles have been around for 20 years. While 529 plans are more widely used among higher-income households, even sophisticated investors sometimes get stumped by the ins and outs of these plans.

Investments in 529s can grow tax deferred; withdrawals are generally exempt from federal and state income taxes—provided you use the funds for qualified educational expenses. Many states offer state tax deductions, even credits, to further encourage saving.

For all their benefits, 529 plans are still often misunderstood. Here's what you may not know:

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They're More Flexible Than you Think

There are no income limitations, and any adult can open an account on any person's behalf. Most plans let participants change beneficiaries for any reason. You can even name yourself as a beneficiary.

The lifetime contribution limits are generous, typically about $200,000 to $350,000 per beneficiary.1 The plans are state-sponsored, but you can participate in nearly any state's plan, although you should first consider your home state’s plan as it may offer benefits exclusive to state residents.  You may even be able to use the savings for elementary and high school education2.  Many kinds of post-secondary institutions are included, such as art institutes, community colleges and vocational schools. You can even use 529 funds for eligible international schools.

Some States Really Sweeten the Deal

Because many states offer state tax deductions—and in some cases credits—it does make sense to start your search in-state.

For example, Colorado is one of a handful of states that generally allow state income tax deductions for 529 contributions to the extent of a person’s taxable income. Other states entice savers with high deduction limits. Illinois and Oklahoma, for example, allow state income tax deductions of up to $10,000 ($20,000 for married couples filing jointly). Still others offer deductions per beneficiary, or let savers carry forward their deductions.

Discuss how different states stack up with your Financial Advisor, but check the details directly with your state and tax advisor before investing.

Advice Matters When Saving for Education

A state tax break is a nice perk where available, but it is not the only factor to consider. For many people, the investment component may be more important than any state tax savings. A Financial Adviser can help you weigh the tax benefits of staying in-state and shopping around for suitable alternatives. Key considerations are investment choices, ongoing fees and manager track records.

One approach is to look for a plan that offers age-based portfolios, which gradually shift the allocation as the beneficiary approaches college. Investors who choose other options (e.g., conservative, moderate or aggressive allocation) should keep in mind that Uncle Sam lets participants change their investment options just twice per calendar year.

An Estate Planning Tool

One of the great features of a 529 Plan is that it enables you to save money for college expenses while reducing the size of your taxable estate.  The contributions you make to a 529 plan are generally excluded from your estate and thus not subject to estate taxes (unless removed from the 529 and used for non-qualifying expenses). It's important to note that you still control the assets and can access your money at any time. 

Anyone, including grandparents, can contribute up to $15,000 per year ($30,000 for married couples filing jointly) to any individual’s 529 plan, without triggering the gift tax. Additionally, they can bundle five years of contributions into one $75,000 contribution ($150,000 for married couples), provided they make the required election on a gift tax return for the year of the contribution.

If you have the means, you can even take advantage of six-year gift tax averaging. To do this, you can contribute one years’ worth of gifts in December, followed by five years of contributions in January, effectively making six years’ worth of contributions in just two months. Keep in mind, however, that if the donor were to die during the five-year period, then a prorated portion of the contribution would be “recaptured” into the estate for estate tax purposes.

Minimal Impact on Financial Aid

The impact on financial aid is typically minimal for 529 savings plans. The short explanation: As long as a parent is the account custodian, the child's financial aid will decrease by no more than 5.6% of the account value.3

Grandparents can contribute to a parent's plan. If they set up their own 529 account, they can pocket state deductions where available and retain control of the account. But going this route may affect financial aid.

One caveat: If your child is the beneficiary of a 529 account that belongs to someone outside the immediate family, the value of the plan doesn't get factored into the federal financial aid formula, but withdrawals are treated as student income. This can affect financial aid the following year. There are ways to reduce the damage, such as saving the funds for the student's senior year—but it's best to think through financial aid implications early.

When it comes to college costs, every dollar counts.

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