What to Do When Your Kid is Ready for College… But Your 529 Plan Isn’t

529 plan
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Years ago, when Junior was just a wee thing, you started a 529 college savings plan. You figured that with regular contributions, you’d be able to make a considerable dent in his college bill. College costs couldn’t possibly rise faster than the inflation rate, right?

Now that it’s time to send Junior off to school, you’re trying not to panic. It feels like you have 2 cents in your kid’s 529 account compared to what they actually need. This is fine. This is fine.

Feeling Pressed for Time? Forward-Fund Your 529 Plan

If you have a 529 plan benefiting a student heading off to school soon and want to give them an extra boost, some states allow you to forward-fund the plan by making five years’ worth of contributions without paying a gift tax on the amount.

The current IRS cap is $14,000 per year per donor, so you could contribute as much as $70,000 — or $140,000 for married joint donors — to your 529 account as a single contribution.

The caveat of forward-funding a 529 is that if you decide you want to make another contribution at any time in the four years following that deposit, it’ll be subject to taxes.

The Pros and Cons of Catching Up an Underfunded 529 Plan

If your beneficiary is about to start college and you wish you had contributed more, it may be worth holding on to those funds instead of putting them in the 529 college savings account.

The longer you contribute to the plan and let that balance add up, the longer you can earn interest on those contributions. Scrambling to contribute now won’t earn you much interest to help build that balance.

On the other hand, if you skip making a contribution to your 529 plan, you miss out on the tax benefits. While you cannot deduct 529 plan contributions from your federal taxes, a student or parent can draw from the account tax-free, so long as they use the funds for higher education expenses.

Plan withdrawals are typically exempt from state taxes, and most states offer an additional tax deduction for 529 plan contributions. Of the states with income tax, only eight don’t allow tax deductions for 529 plan contributions: California, Delaware, Hawaii, Kentucky, Maine, Minnesota, New Jersey and North Carolina.

“I always say never write a check directly to a college,” said Mike Chadwick, president of Connecticut-based Chadwick Financial Advisors. “A lot of states don’t require a holding period. You can put money in your 529 account tomorrow and send it to UConn the next day.”

Being able to pay for college costs with a 529 account can reduce the amount of need-based financial aid your student is eligible for. However, if you could make a significant contribution and reap the tax benefits, it may still be worth making that contribution and risking a lower financial aid package.

But if you’re looking at a smaller contribution that carries little tax benefit, It may be simpler to write a check to the student to put toward their tuition bill.

Where to Find Extra Money to Put in Your 529 Account

If your beneficiary’s college years are creeping up on you, it may be possible to find extra cash to put toward their 529 plan.

Chadwick recommends putting your tax return toward your plan.

“It’s ‘free money’ because you didn’t have it before,” he said. “You won’t miss it if it goes directly into your savings account.”

You can also adjust your contributions at work — 401(k), health savings account or other automatic pretax deductions — to boost your paycheck. Just be sure to put the “extra” money toward the 529 account. Don’t get distracted by the reward of a bigger amount on your pay stub.

But if you take this route, make sure your retirement plan is well-established before trading your savings for your kids’ college education.

“If you don’t save for retirement, you’ll be grossly underprepared for life after your kids are out of college,” Chadwick said. “Think of [retirement and college] together, and understand that when it comes to retirement, there are no loans.”

Your Turn: Do you have a 529 account to help save for your kids’ college education?

Lisa Rowan is a writer and producer at The Penny Hoarder.

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