I’m a big believer in getting bang for your buck. When it comes to saving for college, the 529 plan definitely deserves a place in your portfolio. There are reasons for this, which I’ve written about before, but there are also misconceptions that should be brought into the light.

As a savings solution for the middle class, 529 plans appear to have an image problem. Public perception seems to be that the high account limits and tax breaks offered by 529 plans benefit the wealthy, and certainly there is a great deal of truth to this. If your position is to oppose any sort of provision that benefits folks with lots of money, this probably isn’t in your wheelhouse.

The way I see it, there isn’t much logic in opposing something simply because it benefits someone else (I realize that this makes me almost un-American these days.)   The truth is that there is plenty for the rest of us to like about 529s, if only we pay attention.

Here are the major tax benefits of 529 plans, not coincidentally listed in order of the ascending income of those who benefit most. If you are planning on funding someone’s education, it’s important to understand this savings option.

Tax-free earnings

529 plans offer federal tax-free earnings on qualified withdrawals, i.e. withdrawals that are used to pay for college expenses. Additionally, many states offer this benefit, and some even offer deductible contributions (up to the limit set by the state.) Withdrawals taken to offset a scholarship, employer tuition assistance or veterans benefits are subject only to income tax on earnings, allowing the owner to reap the benefits of tax-deferral for those amounts.

Since the tax-free earning feature appears to be under fire lately, let’s look at what happens if taxes turn out to only be deferred. Consider an investment of $1,000, followed by monthly $100 investments, 7% return rate (net of fees, compounded monthly) over a period of ten years. For a person in the 25% tax bracket, a taxable account would earn $4,354. That same account, tax deferred, would earn $6,420. Taxes upon distribution would bring this number to $4,815 – about 10% more than the earnings in a taxable account.

In the worst case, nonqualified withdrawals are subject to the aforementioned tax on earnings and an additional 10% penalty those earnings. The 10% penalty would bring the earnings number to $4,173. The worst case scenario – where you don’t end up using the money for college at all – costs you $361 over ten years. This picture improves as your tax bracket goes up – at 30%, the numbers are close to equal. Not a terribly risky gamble to take with money that would otherwise be invested in a taxable account.

Accelerated Gifting

Another tax feature of 529 plans is accelerated gifting. For 2015, the gift tax exclusion limit is $14,000 per person. However, 529 plans allow you to front-load up to five years of gifting, so that you can contribute $70,000 to one beneficiary’s account without incurring gift tax.

I know. We’re back to the wealthy again. The degree to which this feature is touted probably feeds into popular misconceptions about who benefits from 529 plans. If you have $70k you’re looking to park somewhere – congratulations. Put the money to work all at once, rather than piecing it out over five years and missing out on potential gains (see my post on dollar cost averaging.)

But it’s important to remember that $70,000 is the high end. The gifting provision applies to any amount over $14,000 (and below $70,000), and I know a few grandparents with that kind of money to pass along. 529 plans allow them to gift money to grandchildren without actually giving it.

The accelerated gifting provision makes 529 plans a useful estate-planning tool, which brings me to my next point.

Estate Planning Benefits

Once assets are gifted through a 529 plan, they are removed from your estate for estate tax purposes (though if you die before the beginning of the fifth year, a pro-rated amount will revert back and be subject to estate tax.) However, since you are the owner of the account, you retain control of the assets. This is my favorite part – you can reduce your estate tax exposure and still keep your money. Furthermore, if you designate a successor account owner, those assets will pass into the hands of your designee without going through probate.

(And yes. The estate tax exclusion for an individual for 2015 is $5.34 million. This one benefits only the wealthy.)

The bottom line is that the tax benefits of 529 plans matter to anyone who might be planning to send a beneficiary to college. And the penalties for not using the money as intended are relatively minor.

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