Is A 529 College Savings Plan Right for You?

If retirement planning is the biggest concern on the mind of the average American parent, saving for college comes in a close second. If you have multiple children who plan on attending an institution of higher learning, you could wind up stretching your budget to make it work. College is an expensive but necessary requirement for most career paths, but loans and grants often come up short on paying the bill.

Thankfully, there are tax-advantaged ways to save for our children’s future college education. Vehicles like Coverdell ESAs and 529 college savings plans offer the possibility of investments with tax breaks if the funds are used for qualified learning expenses. But before rushing to open one, you’ll need to consider a few things, because these types of investment accounts aren’t for everyone. Here’s what you need to know.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

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What is a 529 Plan?

The 529 Plan was created in 1986, named after (you guessed it) Section 529 in the IRS’s revenue code. The purpose of a 529 Plan is to offer tax savings for parents or guardians who wish to save money for qualified education expenses for a particular beneficiary. However, unlike traditional tax-deferred vehicles like IRAs, 529 Plans are operated by individual states and each plan will have their own set of rules and regulations. You may even find a better deal with a plan administered outside your home state.

You don’t have to be the parent of a child to open a 529 Plan. Anyone can open an account on behalf of any beneficiary, provided both parties have a Social Security number. Grandparents, aunts and uncles, and even family friends are eligible to contribute to 529 Plans for future education expenses.

Types of 529 Plans

There are two types of 529 Plans:

  • Education Savings Plans. When most people imagine a 529 Plan, this is the variety they think of. An Education Savings Plan is an investment vehicle where the account holder can purchase ETFs or mutual funds and withdraw the money tax-free if used for qualified education expenses. Tuition, room and board, books, fees, and computers at both college and K-12 schools qualify under this requirement. Investment options, costs, and tax rules will vary depending on the plan you choose.
  • Prepaid Tuition Plans. For those worried about the costs of higher education expanding even further in the future, a Prepaid Tuition Plan will allow you to lock in today’s prices for a beneficiary’s future college career. Like Education Savings Plans, these are run by various different state administrators. Universities enrolled in the plan allow account holders to purchase tuition credits today that can be used by the beneficiary in the future. No investments are made with Prepaid Tuition Plans, so the money has limited fungibility compared to Education Savings Plans.

Not only do you need to choose which type of plan you want, you’ll need to choose a state administrator offering the best deal. 529 Plans are still subject to fees and maintenance costs like any other savings vehicle, so be sure to compare rates. Remember, you don’t need to choose your home state’s plan.

Pros and Cons of Establishing 529 Plans

Here are some potential advantages of a 529 college savings plan:

  • Pro: No Income Limits. Unlike certain retirement accounts, there are no income limits for establishing and funding a 529 Plan. You’ll need to consult your individual plan prospectus for rules on state tax breaks, but federal taxes can be avoided if the funds are used for qualified education expenses, even if the account is owned by a high net worth individual.
  • Pro: Tax Savings. This is the real golden goose with 529 Plans, isn’t it? Withdrawals taken for qualified education expenses aren’t hit with federal income taxes, or state income taxes in many instances. Some states even allow 529 contributions to be deducted from state tax returns.
  • Pro: Prevent Runaway Prices. A Prepaid Tuition Plan is a particularly useful hedge if you think college costs will continue to inflate. By locking in today’s tuition rates, you could save thousands without taking on any investment risk.

Here are some potential disadvantages of a 529 college savings plan:

  • Con: Limited Investment Choices. You’ll be stuck with the investment option your plan provides, which are usually just ETFs and mutual funds (like target-date funds). Additionally, you’ll only be able to change your investment securities a few times per year.
  • Con: Could Affect Student Aid. Assistance for college tuition is calculated based on family income and assets. If you accumulate substantial assets in a 529 Plan, it may limit the amount of federal and state assistance your college-bound child receives.
  • Con: Penalties and Fees. Each individual 529 Plan will come with it’s own set of administration costs and fees, which is why it’s important to shop around. You should also be cognizant of what happens should the funds NOT be used for education expenses. Not only could you lose your tax break, but an additional 10% penalty could be levied if the money isn’t used for college or K-12 education.

Final Thoughts

A 529 Plan isn’t for everyone. You don’t get a mulligan if your intended beneficiary decides to forgo college, nor can you guarantee the investments in a 529 account won’t lose money. Imprudent 529 usage could also lead to a reduction in student aid, which in many cases is free grant money. Always consult with your financial advisor before opening any type of new account like a 529 Plan, even if you have the best of intentions.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

Contact Us

Disclosure

The opinions voiced are for general information only and are not intended to provide specific recommendations for any individual.

Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.