September was National College Savings Month, although it is probably better characterized as National College Spending Month, as anyone who has written out that first tuition check of the school year can attest. And many Americans wrote out that tuition check with money taken from a 529 savings plan.
According to the College Savings Plan Network, there is now $258.2 billion being held in 529 plan accounts, an increase of 5.6 percent over last year. Most of that growth has come from new plans rather than people putting more money into existing ones.
There were about 500,000 new 529s opened over the past year, but the average account in each of them rose by just 1.3 percent, to an average level of $20,934. That might be an issue for some people, because tuition is growing faster than that. The growth of tuition for private nonprofit four-year colleges grew at 3.7 percent during the 2014-15 academic year.
Despite all that growth, many people are questioning whether 529 college savings plans are in fact the best vehicle to use for college savings.
Some pundits have suggested life insurance policies are a viable alternative to the 529, which is an idea of obvious importance to estate planners. Certainly, many clients are able to get more flexibility with life insurance than with a 529, whereas an insurance strategy can also offer many of the tax advantages of a 529 plan
Which makes more sense? The answer depends on both the status of the saver and the status of the prospective college student. Here are seven questions for both planners and their clients to ask themselves:
1. Is there any doubt about whether the prospective student will attend college?
The Internal Revenue Service limits the use of money in a 529 college savings plan to “qualified education expenses:” tuition, fees, books, plus room and board. If the student decides not to go to college, or receives a full scholarship, the client can pull those funds out and pay income tax as well as a 10 percent federal excise penalty. There may also be back taxes on any state tax deductions. The funds can be transferred to another student without penalty, though.
2. Is the prospect thinking of leaving the country for college?
If the student is interested in studying overseas — for instance, if the student has a foreign-born parent — it’s worth noting that 529 plan funds can only be withdrawn without penalty for use at colleges that have been accredited by the U.S. Department of Education.
3. Will the student require financial aid?
When colleges assess a parent’s assets for a student who is applying for federal financial aid, a 529 plan must be reported, but life insurance is not counted.