6 Tips to Kickstart Succession Planning with Your Business Owner Clients
Here are 6 tips you can share with your business owner clients to help kickstart their succession planning.
As college costs rise, saving for tuition and other related expenses may be at the forefront of your clients’ minds. One potential tool to address this concern is investment in a 529 plan. A “529 plan” is an educational savings plan operated by a state or an educational institution designed to help families save for future educational expenses. Plans vary by location, but your client can purchase a 529 plan from any state, regardless of where they live. Sitting down with your client and talking through what’s important to them in an educational savings plan can help them make the best 529 investment.
There are two types of 529 plans; education savings plans and prepaid tuition plans. Discussing the pros and cons of each, and how important flexibility and fees are to your client can help when deciding between the two types of plans. Education savings plans are broader and more flexible, whereas prepaid tuition plans usually have residency requirements and are selective about where funds can be used. Both plans may charge enrollment, application, and/or administrative fees. In general, education savings plans incur more fees than prepaid tuition plans because of the additional account maintenance and management of the investments that occurs in the savings plans.
Education savings plans are more flexible than prepaid tuition plans, as funds can be used at most colleges and universities and public, private, and religious K-12 schools. For this type of plan, your client can choose from a range of investment options, such as mutual funds, ETF portfolios or principal protected bank products. Because these types of plans are dependent on investments, the rate of return may vary. All education savings plans are sponsored by states, state agencies, or educational institutions, as authorized by section 529 of the Internal Revenue Code.
Prepaid tuition plans allow an individual to pay tuition credits or certificates at participating colleges at today’s prices for use in the future, thereby locking in today’s tuition rates. Prepaid tuition plans are stricter than education savings plans because your client can only use their plan funds at participating colleges and universities. This varies from state to state, but generally prepaid tuition plans can’t be used for room and board—only tuition and mandatory fees. This type of plan doesn’t allow your client to use funds for K-12 education either. Prepaid tuition plans aren’t offered in all states, so it’s important to verify with your clients if they even qualify for this type of plan based on where they currently reside.
Additionally, prepaid tuition plans are not guaranteed by the federal government. Some state governments guarantee the money paid into the plans that they sponsor, but some do not. That’s why it’s important to check if your client’s state plan is guaranteed. If their prepaid tuition payments aren’t guaranteed, your client could lose some or all their money in the plan if that plan’s sponsor has a financial shortfall.
To get started, you’ll want to compare the state’s 529 plan options with your client. This online tool from collegesavings.org can help you and your client with this task. Maximum contributions vary depending on the state, as well as asset-fee ratios, account maintenance fees, and if they offer more rare features like contribution matching. Other details to compare and discuss with clients are initial deposit minimums, as well as any potential minimum continuing deposit requirements so your client can budget their income for any future required deposits accordingly.
Fees are an important part of any discussion on 529 college savings plans with your client because any additional expense will ultimately lower their return on investment. Fees and expenses vary on the plan type, how the plan is sold, and other factors.
Education savings plans may have asset management fees, but that will depend on the investment option your client chooses. If your client purchases through a broker, they may be subject to additional commissions or fees there as well. Prepaid tuition plans may only charge an initial enrollment fee and ongoing admin fees.
Assets in your client’s 529 savings plan may be used by the named beneficiary for a variety of expenses related to college, graduate, or vocational school education. Beneficiaries can use the funds to purchase books and school supplies, room and board (including campus food and meal plans), computers, internet, and software for schoolwork (as required by the school or specific courses). These funds can also be used for special needs and accessibility equipment.
As a relatively new addition to 529 plan rules, your client can also utilize these funds for K-12 education tuition and fees. There are some limits on this, however; education savings plans for K-12 can only pay up to $10,000 per year per beneficiary for tuition at any public, private, or religious school. Additionally, 529 funds can be utilized for student loan repayments.
It’s also important to discuss with your client what 529 plans cannot be used for. Summer camp, music lessons, art classes, or similar events or non-school sanctioned classes for children are NOT eligible.
In general, the earlier your clients start saving in their 529 savings, the greater their tax benefits will be, because this will allow more time for the contributions to grow and accrue potentially tax-free earnings. These benefits can be lost, however, if they need to withdraw money within a short period of time after it is contributed. If they use 529 account withdrawals for qualified higher education expenses or tuition for elementary or secondary schools, these earnings are not subject to federal income tax and, in many cases, state income tax. Check with your client’s state to see if state income tax applies.
However, if 529 account withdrawals are not used for qualified higher education expenses or tuition for elementary or secondary schools, they will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings.
An important question your client might be considering is “are 529 contributions tax deductible?” The answer to that question will probably sound familiar—as with other details of the 529 plans, it depends on the state. Many states offer state income tax deductions or grants, but it’s important to discuss the details with your client because there could be additional restrictions and requirements attached to these benefits.
Nationally, one of the great benefits to 529 plans is that withdrawals for qualified purchases are not taxed at the federal level. In general, both education savings plans and prepaid tuition plans allow your client’s money to grow tax-free over time.
There are different situations in which your client might not use all the 529 money they have saved. Luckily there are options to address this situation. For example, your client could keep the money in the account and continue to save for future education expenses like additional coursework and/or advanced degrees. 529 savings can be used for accredited classes, master’s programs, law school, and other similar opportunities for advanced educational degrees—limitations on this will vary based on your client’s plan and location. Alternatively, your client could also change the name of the beneficiary of the plan so that another individual could use the remaining balance.
If a beneficiary of a prepaid tuition plan doesn’t attend a participating college or university, the plan may pay less than if the beneficiary attended a participating college or university. It may only pay a small return on the original investment.
Applying for financial aid is a well-known part of the college application process, so it’s good to make your clients aware that 529 plans typically negatively impact the beneficiary’s ability to qualify for need-based aid. This could also affect eligibility for K-12 financial aid in some cases. Each educational institution will treat 529 plan assets differently, but overall, these accounts can help offset potential debt by lowering the need for loans.
You can read more on Why Clients Need a Financial Plan for College on our blog, and stay tuned for the rest of our saving for college series when we cover Coverdell Education Savings and UGMA Accounts.
This content of this article is provided for informational purposes only and should not be construed as investment, tax or legal advice. The information provided is based on current laws, which are subject to change at any time, and has not been endorsed by any government agency.
Nationwide and its representatives do not give legal or tax advice. An attorney or tax advisor should be consulted for answers to specific questions.
Unused 529 Funds? Here Are Your Options (my529.org)