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Saving for College in California: Funding Amounts, 529 Plans, Taxes

Saving for College in California: Funding Amounts, 529 Plans, Taxes

May 07, 2024

Saving for higher education while balancing our day-to-day expenses is stressful. That's especially true here in California, where our cost of living is so high. As a parent of three children myself, I can empathize. Drawing from my experience as a financial advisor, I advocate for a blended strategy: kickstarting a plan with a 529 and complementary financial avenues in the early years. 

Yet, friends and clients have a common worry: the fear of overloading education savings accounts, which is valid in today's evolving landscape where traditional academic paths are no longer the sole route. 

Our go-to advice is to avoid overinvesting in these accounts, especially if your funds end up tied down for extended periods. Our recommendation leans towards striking a balance between saving enough to cover somewhere between a state institution and an elite university like Stanford. 

Also, given California's absence of 529 tax incentives seen in other states, it's prudent to diversify your savings strategy, possibly incorporating alternative investment avenues. Crafting a tax-advantaged, personalized plan tailored to your goals is where your financial advisor can help. 

To get started, here’s the run-down on 529 plans. 

What is a 529 Plan? 

A 529 plan is a special, tax-advantaged savings account targeted for education costs. In California, these plans allow tax-deferred growth and tax-free withdrawals for a variety of educational expenses, making them an ideal saving tool.  

Tax Advantages and Financial Benefits 

California residents considering saving for college can leverage several tax advantages with a 529 plan: 

  • Tax-Deferred Growth: The growth of investments in a 529 plan is tax-deferred at the federal level, making it a financially savvy way for funding higher education expenses. 
  • Tax-Free Withdrawals: When funds are withdrawn from a California 529 plan for qualified education expenses such as tuition, room and board, books, and other necessary supplies, these withdrawals are exempt from federal and state taxes. 
  • Generous Contribution Limits: The state of California allows contributions up to $529,000 per beneficiary across the lifetime of the account, allowing substantial savings for future educational costs. 
  • Estate Planning Benefits: Contributions to a 529 plan count as gifts for tax purposes. This allows for accelerated gifting which can reach up to five years' worth of contributions without exceeding the gift tax exclusion. 

Unfortunately, as mentioned above, California doesn’t offer a state income tax deduction for 529 plan contributions. The high contribution limit is intended to compensate for this disadvantage. 

Eligible Educational Expenses 

California's 529 plans cover a spectrum of educational costs, not just tuition for traditional four-year degrees. Funds can also be used for: 

  • Tuition and fees at eligible 2-year colleges, vocational schools and trade programs 
  • Room and board expenses for students enrolled at least half-time 
  • Supplies, books, and equipment needed for education 
  • Computers, software and internet access when enrolled 
  • Apprenticeships 
  • K-12 private school tuition (up to $10,000, with other tax limitations) 

What If the Child Doesn’t Attend College? 

If the 529 plan funds exceed the actual education expenses, or if your child's aspirations aren’t academic, you still have options. 

Most notably, you can change the beneficiary of the 529 plan to another qualifying family member without tax penalties. So, you can set up accounts for multiple beneficiaries and if one doesn’t use the funds, they can be transferred to another with some paperwork. 
Qualifying family members can also extend beyond sons and daughters to grandchildren, nieces, nephews, or yourself. This is a choice for extended families or adults with future higher education goals. 


Repaying Student Loans 

A notable flexibility of 529 College Savings Plans is the ability to use up to $10,000 to repay the beneficiary's student loans, further extending the utility of the funds beyond direct education expenses. 

Estate Planning and Gifting 

Contributions to a 529 plan are considered gifts for tax purposes, which can be strategically used for estate planning. California allows a unique gifting feature where you can front-load five years' worth of contributions in one year without incurring the gift tax, potentially lowering your taxable estate.  

Rollover to Roth IRAs 

A new rule helps you rest easy knowing that you may have added options to avoid penalties and taxes if your account is overfunded. In this situation, you would be allowed to roll up to $35,000 in funds to a beneficiary’s Roth IRA without penalty. 
Keep in mind that your 529 must have been open for at least 15 years, so changing beneficiaries could restart the 15-year clock. Also, these fund transfers can’t exceed the 2024 Roth IRA limits ($7,000 with an extra $1,000 catch up contribution for those over age 50 and a lifetime limit of $35,000).  

In short, navigating the complexities of 529 plans and other savings vehicles requires careful consideration of your circumstances and goals. As experienced financial advisors with in-house tax experts, we would be happy to help you set up a plan that aligns your short-term cash needs with your educational goals well into the future.  

Contact us today for a free, no-obligation consultation and take the first step toward securing your child's future. 

The 529-to-Roth-IRA rollover option is so new that the IRS may yet issues guidance that impacts this interpretations of the requirements.

* 529 plan withdrawals for non-qualified educational expenses are subject to a 10% IRS tax penalty and are taxed as ordinary income.

* 529 plan tax-free withdrawals must be used for qualified educational expenses, withdrawal may be subject to income taxes, depending upon the participant’s state of residence.

 * Units of the 529 plan investment options are municipal securities and may be subject to market value fluctuation.

* For more complete information about a 529 educations savings plan, including investment objectives, risks, fees, and expenses associated with it, please carefully read the issue’s official statement before investing. In can be obtained from your financial professionals. You should consult with your financial, tax, or other professional to learn more about how state-based benefits (including any limitations) would apply to your specific circumstances.