Is a 529 Plan Still Your Best Bet?

NC tax break no longer available
With the cost of living soaring each year, many parents start thinking ahead to college as soon as they’re done counting their newborn’s fingers and toes. Not a bad idea. According to the U.S. Department of Education, the average cost per year of attending a public university is more than $15,000, while the average cost per year of attending a private school is around $33,000.

Since 1996, parents have had the option of saving for college via a 529 plan. Named after Section 529 of the Internal Revenue code that created it, this type of education savings plan is operated by a state or educational institution and is designed to help families set aside tax-free funds for future college costs. Anyone — grandparents, friends or anonymous benefactors — can contribute to the account.

But in December 2013, the North Carolina 529 plan tax break ended. While other states have retained tax-free 529 plans — and even increased the deductible (Nebraska, for example, allows married couples to file up to $10,000 jointly) — any money North Carolina residents contribute to their 529 plans will be taxed by the state.

Previously, N.C. taxpayers could deduct up to $2,500 ($5,000 on a joint return) for qualifying contributions to the fund, regardless of a family’s adjusted gross income. In recent years, according to the N.C. Department of Revenue, families in North Carolina saved more than $6 million dollars, collectively.

Fortunately, these earnings still enjoy a federal tax break. “Earnings from 529 accounts are not subject to a federal tax; however, contributions to a 529 plan are not deductible,” says Andrew Belasco, a licensed counselor, independent educational consultant and CEO of College Transitions, a college-planning consulting company.

Because 529 plans are earmarked on a family, not individual, basis, any child in your family can use the funds, as long as the money goes toward that child’s education. So, kids can share the funds or, if there’s excess, parents can pick up courses toward an advanced degree themselves. 

Other Options
You can still contribute to your family’s 529 plan without the tax break, but there are other college investment options at your disposal.

You can put money in a general investment fund that has not been earmarked specifically for college costs. This way, you’ll be saving money, but if your child decides not to attend college (or wins a full-ride scholarship), you can use the money elsewhere, like your own retirement. As with any investment, this money will be subject to usual economic fluctuations, since stocks rise and fall.

You can contribute up to $2,000 a year to a Coverdell Education Savings Account, which is free from federal income tax and can be used to pay for qualified education-relation expenses, including college tuition. Because of its $2,000 annual cap, you’re limited to how much you can save, and the funds must be used by your child’s 30th birthday or else taxes and a penalty will be applied. Note: If a beneficiary is unable to use the funds before his or her 30th birthday, Belasco says he or she “can avoid penalties/taxes by ‘rolling over’ the account to another (younger) family member.”

Save the old-fashioned way — not under a mattress, but by opening a traditional savings account. You would need to start early — very early, like when your child is an infant; get a good interest rate; contribute regularly; and be diligent about never withdrawing funds.

Deduct against future earnings. In other words, take out a college loan. The benefit to this is if you absolutely don’t have the funds, your child can still attend college. The drawback, of course, is that interest rates over time can make paying the loan back challenging, and saddling your student with loans right out of school can be demoralizing and challenging. But the option is there and, with diligence, the loan can be repaid.

Invest in a Roth IRA. Again, you’ll enjoy a tax break, but annual contributions are capped, so you have to plan wisely. Unlike the Coverdell ESA, there’s no age time-out to use the money for education. Also, if you don’t use all (or any) of the funds for education, you will still have built a nest egg you can use for retirement.

Need help planning for college and finding out how to pay for it?

The College Foundation of North Carolina (CFNC) helps North Carolina families plan and apply for college. Visit cfnc.org for more information.

How much will you need to put your child through college? Savingforcollege.com features a simple calculator you can use to determine the estimated costs for your child’s college education. Just plug in your child’s age and the calculator does the rest, generating how much you’ll need to save each month.

Learn about colleges and financial aid, and access an individualized step-by-step plan to approach college at bigfuture.collegeboard.org.

Visit the U.S. Department of Education’s Free Application for Federal Student Aid at fafsa.ed.gov to learn about available funds and how your student can qualify.

Kathleen M. Reilly is a freelance writer and mom in the Triangle.