Paul Meloan – Vested Interest

As a follow up to my earlier post on saving for college, I wanted to take a further look at 529 plans.

Maryland’s 529 plan began in 2001. It is operated by mutual fund giant T. Rowe Price out of Baltimore. Note that there are really two types of 529 plans: pre-paid tuition plans and savings plans.  I’m only talking about the savings plan option here.

The Players: Opening an Account

All accounts have (1) an owner and (2) a beneficiary.  It can be anyone, but for our purposes I will assume it’s the parent opening the account. The owner and beneficiary are usually two different people, but it could even be the same person. The owner controls the account at all times. The beneficiary will never control the account.  This difference alone is useful: for generations parents have gifted money (presumably for college) into UTMA (uniform transfer to minor) accounts. They then confront the fact that the money becomes the legal property of the kid at age 18 or 21.  529s avoid that indigestion.

The Money Goes In: Plan Contributions

Parent makes a contribution to the account and receives an immediate Maryland income tax deduction for the amount of the contribution up to $2500 per year. Many states have 529 plans, but Maryland only gives a tax deduction to Maryland residents to contribute to the Maryland plan and not to any other state.

Give more? No problem. The deduction for gifts over $2,500 carries forward for up to 10 years. (NOTE: if you want to give more than $25,000 per beneficiary it may make sense to look to another state after you’ve maxed-out your Maryland deduction). A gift of up to $14,000 qualifies for the annual exclusion from gift or estate tax. This means it does not need to be reported to the IRS.  Gifts above that even get special treatment from the IRS in terms of stacking annual exclusion gifts for multiple years. If you’re feeling generous, talk to a pro before you do this to make sure you get the details right.

The Money is Invested

Our parent/owner now has a decision to make on how the funds are invested. Most persons choose an age-based allocation. For younger children the assets are invested more aggressively (greater allocation to stocks). As the child matures the allocation automatically becomes more conservative (more bonds and cash). Alternatively, the owner could choose a static investment strategy that does not change over time. The investment risk belongs to you! Accounts can and do lose value when the market tanks. However, since markets tend to go up over time, a plan held for 10-20 years should benefit from market appreciation.

T Rowe Price manages the underlying mutual funds within the investment plan for a fee.  The age-based portfolios cost between 0.48% and 0.67% per year, which isn’t bad, but isn’t great either.  All plans also pay an annual 0.13% fee to the state for program administration costs, as well as some other fees. Bottom line: the state tax deduction is more valuable than contributing to a plan with lower fees, so the fees are a necessary drawback.

The Money Comes Out: Plan Distributions

Upon entering college the funds can be withdrawn to pay tuition, room & board and mandatory fees at any institution that qualifies for federal education assistance.  This means our student could enroll pretty much at any college, university or even trade/technical school in the U.S.  They need not be used at a Maryland college.  The funds can be sent directly to the school or used to reimburse the owner for expenses she has paid.

The biggest benefit on exit is that if the funds have been used to pay for qualified expenses then any growth in the assets is 100% tax free from both federal and state income tax.  There is no other investment available to affluent families that permits tax free compounded growth in this manner. This, by far, is the biggest economic benefit to families that will be facing expensive college bills.

Maryland’s College Savings Plan has a web site that includes much more detailed information, and I encourage any Maryland family saving for education to read it closely.  If you wish to compare Maryland to other state plans, the web site Saving For College does a good job evaluating all the options.


Paul Meloan is the co-founder and co-managing member of Aegis Wealth Management, LLC, in Bethesda, Maryland USA. Before Aegis Paul was a practicing attorney as well as working in the tax practice of Ernst & Young, LLP.

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