Don't Fall into These Traps: The Ultimate Guide to 529 Account Mistakes

Welcome back to another episode of We're Talking Money. I'm Dustin, this is Phil, financial advisers here at OmniStar Financial Group. Today we're going to be talking about 529 plans. This is a very common tool to use for qualified education expenses, but we're seeing more and more mistakes happening in the marketplace and bad information. Today we're going to talk about the top five 529 mistakes that you want to avoid.

So the first one is waiting too long to start. Dustin, we see this all the time. People wait literally until their kids are about out of high school and they say, "Hey, do you think I should fund a 529 plan?" You need to start as soon as possible. In fact, it's not too early to start when the child's born. The longer you let that money work inside the 529 environment, the cheaper the college cost becomes. So in other words, if you put 20 or 30,000 in this thing over time, but it doubles or triples or quadruples, then you've just reduced your overall outlay for the cost of college, or paying for that cost of college.

The other one is under the SECURE Act, Dustin, we can now roll or move leftover money in those 529 plans to a Roth IRA for your beneficiary, but that plan needs to be in effect for 15 years before you can take advantage of this new rule. So you want to start early, not only to reduce the cost of college because of the growth, but you also want to be able to roll what's left to the Roth, and you can't do it prior to 15 years.

Mistake number two: not contributing regularly and missing important tax deadlines. You can contribute to a 529 plan every year and still stay under the gift tax exemption, so you don't have to file any gift taxes. Also, what's important to know is you can actually give in advance five years of gift tax exemption into a 529 plan if you want to get money out of your estate. So for example, for 2023, 17,000 per spouse per child is the gift tax exemption. So what that means is 34,000 to one child, in this case going to college, or to fund the 529 plan. We can pull five years of gifts, so $170,000, get it out of your estate, put it in the 529, and depending on where they go to school, it's likely you won't have to make any more contributions to that 529 plan again, because that's going to be enough money.

And I think you just said something that's so important that I just want to remind listeners: it's rare for a 529 to ever be overfunded. In other words, people don't usually end with a lot of money left in the 529. Don't be afraid to get this thing fully funded. There are ways to deal with the money at the end. You can even change those beneficiaries. But don't underfund. Make sure you're funding it at the proper amount or the proper levels for your needs.

All right, so that brings us to mistake number three, and that is not maximizing the tax benefits of a 529 plan. Now, some people would say, Dustin, that, "Oh, well, the tax benefit is once you get the money in, it grows tax deferred, and if you pull it out for qualified expenses, there's no tax." That's true, but there's one more, and this isn't in every state, but some states allow you to pre-tax or tax deduct all of the contributions. In fact, some states limit it to, say, a th000 or maybe a little more. Some states will allow you to put as much as you want in the 529 and you get to fully deduct all of those contributions. Now, we're broadcasting in the state of North Carolina. We don't allow tax deductions here, but plenty of states do. We're going to put those in the description of our video, so if you want to know what those states are, check out the description. You'll see what those states look like.

But you put money in, you don't think about it again until your child's 18, and then all of a sudden now you're ready to really get serious by your 529. Well, that's not the time to do it. You want to be serious about the investment selection and make sure you're choosing the right allocation all through your child life, so by the time they do reach that college age, you're ready to go and you've know that you've taken advantage of market conditions.

Yeah, great point, Dustin. And in that mistake, here's what we see a lot. You get started, you do that old set-it-and-forget-it thing, and then all of a sudden we go through a major market correction. You've been invested too aggressively, and all of a sudden that account value goes down just about the time you're ready to send that kid off to college, and now college costs you even more because you didn't pay attention to the investment. So make sure you don't let this one go by the wayside. And if you're not sure how to do it, you want to work with your advisor or find someone who can help you make the right decisions for the right allocation for your situation.

All right, so here we are at mistake number five, and this is not using funds for qualified expenses. You have to be mindful of what you're spending the money for when you're bringing that money out of a 529 plan. If you're not using it for qualified expenses, meaning those educational expenses that fit the criteria of a qualified expense under 529 rules, that means you probably are going to be subject to some penalties, and that means extra taxes. Nobody wants that. You can avoid it, but you have to know what you can spend the money for, and that means you got to take out the right amount. Don't take out too much, only what you need.

It's a great point, Phil. For example, if you have to pay a bill before the end of the year, make sure you take out of the 529 plan in December so the years match up. Otherwise it might be seen as a non-qualified expense, and then you'll have to pay those penalties and taxes you're talking about. And if you're not sure, there's plenty of resources out there. One, your financial advisor should know, but two, if you just call whoever is holding your 529, they have specific departments just for 529 plans. I know Fidelity does, and they can answer any question that you have and give you the right guidance.

Hey, and Dustin, one more thing when it comes to that timing. If you've got expenses that are qualified in December and you're push for time and you don't think you can get that distribution to offset those expenses, wait till January. Pay them in January. If it's a tuition payment, for example, pay it in January. Now you have all of that next year, so a full 12 months, to get your distribution to give yourself back the money that you just spent on tuition.

Dustin, we just covered five mistakes. We see them more now than ever, and that's because 529s are so popular. So the best place for you to start is go through these five mistakes, make sure you avoid them. Don't forget to start early, don't forget to maximize the tax benefits, know the rules, and if you don't know those rules, contact someone like us or your financial adviser to give you some guidance so that you can take advantage of these very powerful tools.

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