3 reasons to open multiple 529 college savings accounts
The college savings accounts known as 529 plans have multiple benefits for parents saving for their children's education: tax savings on earnings when used for qualified expenses; additional tax deductions on contributions in certain states; and the ability to front-load accounts without the threat of a gift tax.
These plans also offer the flexibility to change the beneficiary from one relative to another, which makes opening one larger account with pooled resources an attractive solution for college-saving families. But experts agree that, in these three circumstances, opening more than one 529 is actually the best option.
1. You're saving for multiple children.
All 529 plans have a named custodian, the parent, and one named beneficiary, the child, says Alex Yeager, a certified financial planner with Everlong Financial in Austin, Texas. "Parents could use one plan to save for multiple children, but the funds can only be used against qualified expenses incurred by the named beneficiary. If a parent has two kids in school at the same time, then only distributions for the named child are covered."
Any disbursements for other children would be subject to a 10 percent penalty and income tax.
Also, opening separate accounts allows parents to choose the proper investment allocation for each child.
"If their children are more than a couple of years apart in age, parents will most likely have different investment objectives for their college savings," says Ronald Ramsdell, founder and president of College Aid Consulting Services. "They may decide that one particular 529 plan has better equity-weighted investments – suitable for a young child – while a different 529 plan is more attractive for an older child because of its conservative options."
Finally, says Yeager, opting to open a 529 for each child can ensure parents meet their savings goals.
"The psychology of having separate accounts helps a parent to see if they are on track, overfunding or underfunding the specific account," he says. "Having one 529 plan hides the underlying distribution of funds for each child, and if one child uses up all the money for his education, he leaves the remaining siblings with the option of going to a less expensive school or taking on loans."
2. You want to supplement a prepaid 529 account.
The major benefit of prepaid 529s is that they allow parents to lock in present-day tuition rates for future use. The drawback, however, is that the funds within prepaid accounts typically cover only tuition and mandatory enrollment fees.
Parents can open a regular 529 account to save for additional qualified expenses, such as books, computers, and room and board, says Nancy Farmer, president of Private College 529 Plan, a prepaid tuition plan sponsored by more than 275 private colleges and universities.
Even if parents choose not to open a 529 savings plan in addition to their prepaid account, they will still have to supplement with another prepaid plan if they have more than one child. Like 529 savings accounts, prepaid 529s are also tied to a specific student.
3. You want to maximize tax benefits.
While all 529s offer tax advantages when the funds are used for qualified educational expenses, some states offer additional tax benefits for individuals contributing to their home state's plan.
The state of Virginia goes a step further by offering a tax break per opened account – as opposed to the "one deduction per taxpayer" rule of other states.
"In Virginia, the tax deduction for in-state 529 contributions is up to $4,000 per account, on a 'per account holder' basis," says Larry Solomon, director of planning and investments at OptiFour Integrated Wealth Management in McLean, Virginia. "In other words, in a family of four with two kids and two parents, each spouse could open an in-state 529 plan for each child and get a total of $16,000 in Virginia state deductions."
That saves $920 in state income taxes for a family paying a 5.75 percent rate, he says.
But parents don't have to live in Virginia to leverage state tax advantages to ramp up savings.
Emily Boothroyd, an attorney and financial planning specialist with Westport Resources in Westport, Connecticut, says opening an additional plan in the state where the child's grandparents or other relatives live is one example.
"You get a state income tax deduction in Connecticut when you contribute to your child's plan, but your mother living in Missouri won't benefit from her contribution to Connecticut's plan, because it's out-of-state for her," she says. "If you know you have a relative who plans to help with college, opening an account in her state will potentially have tax benefits for her and might encourage her to contribute."
Trying to save for college? Get tips and more in the U.S. News College Savings 101 center.