What are the pros and cons of a California 529?

As parents get ready to send their children off to college, they are usually at the apex of careful financial planning that began in the nursery. While there are many ways to save for college, whether through a trust, IRA, or other investment tool, many people in California and elsewhere opt for a tax-advantaged 529 college savings plan.

Unlike some other states, California’s 529 plan does not offer a tax-deductible break on contributions. But it is still an excellent means of gifting as a revocable wealth transfer tool. Families can invest funds tax-free and then use them for qualified expenses, such as:

  • Tuition
  • Fees
  • Books and supplies

Recent tax laws have widened the options for qualified expenses that a 529 plan can provide, such as for secondary school education costs of up to $10,000 per year per child. With a 529 plan, individuals can gift up to $15,000 per plan per year without a penalty, and this amount doubles for a couple. Or, they may give one contribution of up to $75,000 every five years, or double this amount for a couple. The limit of a 529 plan in California is $529,000.

What are the disadvantages of a 529 plan?

Although 529 plans offer many wealth transfer benefits to parents, grandparents and other family members who wish to minimize their own tax exposure, they do have limits that other estate planning tools do not. Because withdrawals that do not go toward approved education expenses will impose an automatic 10% federal tax on the earnings portion, plus a 2.5% state income tax, withdrawing more than needed could trigger a penalty.

Unless parents start a 529 plan early, it can be challenging to contribute enough within the remaining time frame. If market volatility creates losses close to high school graduation, there may not be time to recover before a child leaves for college. In addition, 529 plans often have limited investment options that may not provide the needed diversification.

Are there other options?

Trust account plans are custodial trusts under state law that hold savings for a child with more flexible withdrawal options, as they are not limited to higher education expenses. While a custodian or trustee manages this type of trust, the funds will revert to the beneficiary at the legal age according to state law. The two basic types are:

  • Uniform Gift to Minors Act (UGMA), which mainly hold securities.
  • Uniform Transfer to Minors Act (UTMA), which may hold other assets.

San Jose residents can benefit from a comprehensive overview of possibilities that will be best suited to their unique circumstances.