529 plans are smart strategy when saving for college

When it comes to flexibility, the 529 is a sound strategy in the investment world.

Its purpose is to establish an account for educational expenses after high school. That means an accredited traditional four-year program, a technical school, a one-year ski school, or perhaps even a three-month school to become a medical technician. You get the idea.

The label comes from where the plan exists in the IRS Code, Section 529. The owner is called the participant and is in charge of the plan; he or she may choose to remove money or change the beneficiary at any time.

With this strategy, choices abound.

Here’s an example:

Suppose I select the Oregon 529 plan. Even though I don’t live in Oregon, I may like the plan. You might select a plan issued by your state of residence, as there may be benefits to you.

As owner, I start the 529 plan with a minimum of $250. Anyone can contribute any amount to the plan provider. For instance, I name my grandson Fletcher as beneficiary.

AGGRESSIVE START

When Fletcher is 5 or younger, the plan provider invests all contributions into an “aggressive growth allocation” model they manage. As Fletcher turns 6, the plan provider automatically takes the entire account balance and changes the account to “growth allocation.”

Fletcher’s new account remains invested in this manner until age 11. Then, once again the plan provider automatically takes the entire account balance and changes the objective from “growth allocation” to “moderate allocation.”

There will be more changes as Fletcher gets closer to 18 and the expected state of college. However, if he waits to start college, the plan will wait for him. There is no forced liquidation.

The strategy is to become more conservative so that the money will be less volatile when it is needed for college.

Suppose through the years the contributions total $25,000 and have grown to $100,000 for a growth in capital of $75,000.

Fletcher is now 18 and ready for college. However, he announces that he is not going to college and instead wants to be a yoga instructor. (We love him anyway).

As owner of the 529, I change the beneficiary to his younger sister Lucy, who in a few years wants to attend an accredited college. That college will open a checking account for Lucy.

Lucy says she needs $10,000 for her first semester. I contact the plan provider and authorize them to send a distribution of $10,000 to Lucy’s checking account at ths school. The college withdraws what is needed for Lucy’s room, board, books, tuition and other approved items.

Since the $10,000 is going to an accredited college, there are no taxes on that distribution. There is now $90,000 in the account, assuming no account fluctuation in value.

MOVING FORWARD

Lucy decides she wants to go to medical school to become a doctor. We might start contributing again to the account because Lucy could need more money for school.

Through the years, the account sends more distributions to Lucy’s checking account. Lucy graduates and the balance in the account is $40,000, which is composed of the original contributions of $25,000, plus any additions, and gains of now $15,000.

Lucy graduates and has no desire at this time for further education. As owner, I decide to change the beneficiary to myself. Why? Because I’ve always wanted to attend the accredited Arnold Palmer Golf Academy and also a school in France to study cooking. I can use the remaining $40,000 in the account for my own education, tax-free.

On second thought, I’ll have the plan provider send me a check for the remaining balance of $40,000. Since there are gains of $15,000, I will owe income taxes on the gain.

Section 529 of the IRS code is a flexible benefit that can be used by parents and grandparents for family members and has many other details worth exploring.

This story was originally published February 27, 2017 at 11:48 AM with the headline "529 plans are smart strategy when saving for college."