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Chapter 6: The Pros and Cons of 529 Plans

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So far in our series we’ve introduced you to the concept of college savings plans and covered the basics of what 529 college savings plans are for and how they work. In this article, we’ll take a more in-depth look at the pros and cons of a 529 college savings plan to help you decide if this is the right investment account for your family. 

As a recap, 529 plans are tax-advantaged investment accounts that can help you start saving for college for your child. While 529 college savings plans have a lot in common with ESAs, especially when it comes to paying for college, there are some key differences.

To get you started, here’s a complete breakdown of 529 college savings plans. Keep reading or use the links below to dive in.

Pros of 529 Plans 

We’ll start by talking about the pros of 529 plans, of which there are many. 529 plans are one of the most popular options for parents who want to start saving for college for their children, and here are some of the reasons why.

Tax-Free Growth

Tax-free growth is one of the biggest benefits of choosing a 529 plan. Many types of investment accounts have their earnings taxed upon withdrawal, but that’s not the case with a 529 plan if you use it strategically. As long as the earnings from a 529 plan are used for qualifying education expenses, they can be withdrawn by your child tax-free.

Contribute More Money

Another benefit to choosing a 529 college savings plan is the fact that you can contribute significantly more than you can with an ESA. With ESAs, you can contribute a maximum of $2,000 per child, per year. With a 529 plan, you can contribute up to $16,000 per donor, per beneficiary, and all of those contributions will qualify for the annual tax gift exclusion. Contributions beyond $16,000 will require you to file a gift tax return.

Financial Aid Eligibility

Certain assets and types of retirement accounts can make it extremely difficult for your child to qualify for financial aid. Different types of assets are treated differently when it comes to financial aid eligibility, but a 529 plan has a minimal effect on the financial aid eligibility of your child.

A 529 plan is treated as the parents’ asset, which means only 5.64% of the value of the account is counted against your child’s financial aid eligibility. This is especially important if your 529 plan is only going to pay for a small portion of college.

Tax Breaks

529 college savings plans are not subject to federal taxes. And, depending on what state you’re in, you may qualify for tax breaks at the state level when you contribute to a 529 plan. These tax breaks can help you get even more out of your 529 plan investment, but they’re not applicable in every state. 

While learning how to budget better and making other small changes can help you save for college for your child, the tax breaks and tax advantages that come with 529 plans make a huge difference in terms of return on investment.

Applicable to K-12 Expenses

Most people think of 529 plans as college savings plans, but they can actually be used for other education expenses as well. In fact, you can even use a 529 plan for qualifying K-12 education expenses. While most people use 529 plans to save for college for their children, you don’t have to worry about paying taxes on 529 earnings even if you’re using them to pay for qualifying K-12 education expenses.

Can Go Toward Student Loan Debt

There’s a lot to consider when it comes to the cost of school expenses, and that includes student loan debt that your child has to repay when they’re finished with college. Fortunately, your child can use the earnings from a 529 plan to pay student loan debt without paying taxes on those earnings. 

It’s important to keep in mind that beneficiaries can withdraw a maximum of $10,000 in their lifetime to pay off student loan debt. Still, this can help your child get a head start on paying off their debt.

Transferable

If one of your children decides they’re not going to college, a 529 plan actually gives you the ability to transfer the plan to another child. There are no federal taxes when transferring a 529 plan to qualifying members of the beneficiary’s family, and there’s typically no state or local tax liability either. 

However, you can only roll a 529 over to another 529 with no income tax once every 12 months, so that’s important to keep in mind.

Options

There are actually two types of 529 plans you can choose between: education savings plans and prepaid tuition plans. In this article, we’ve mostly been talking about education savings plans, which allow you to invest money that grows tax-free and withdraw that money to help cover qualifying education expenses. 

With a prepaid tuition plan, you can purchase college credits at their current price that your child can use when they go to college. This can be beneficial because college credit costs may be lower now than they will be when your child goes to college.

As you can see, there are many ways in which a 529 plan can be an advantageous college savings option.

Cons of 529 Plans

While 529 plans can help cover education expenses and free up money for your child’s living expenses during college, there are disadvantages to these plans as well. While these disadvantages are fairly minor, you may want to weigh the pros and cons before deciding if a 529 plan is right for you.

Must Only Be Used for Education

First off, 529 earnings must be used to pay for education in order for your child to withdraw the money tax-free. Only certain education expenses qualify, so you need to make sure you’re withdrawing money for qualifying expenses to avoid taxes. This becomes more difficult when you’re using a 529 plan to pay for K-12 education expenses, such as private school. 

If 529 savings plan funds are used for non qualified withdrawals, they may incur a 10% penalty. And, they may be subject to federal income tax.

Tax Benefits Don’t Apply to Every State

While some states do offer tax breaks for contributing to a 529 plan, there are lots of states that don’t offer these tax breaks. Depending on where you live, you may not be eligible for tax breaks for contributing to a 529 plan, and those tax breaks can make it easier to contribute. Even still, you get the benefit of tax-free withdrawal when your 529 plan is used to cover education expenses.

To find out if this disadvantage is applicable to you, look up the rules surrounding 529 plans for your state.

Limited Control on How Money Is Invested

If you’re interested in investing on your own without the help of an advisor, a 529 plan may not be right for you. 529 plans don’t allow for self-directed investments, which means you don’t get as much control over what you’re investing in. There are other types of investment accounts that may give you more say over your investments, so those alternatives are something to consider if you want complete control.

Fewer Investment Options

Speaking of investing with a 529, your investment options are limited. With an ESA, you can invest in pretty much all of the securities, including stocks, bonds, and mutual funds. Because 529 plans don’t allow for self-directed investments, investment options are a bit more limited.

Fees

This is one of the most minor concerns when it comes to 529 plans, but it is worth mentioning that there are fees for many 529 plans. Some 529 plans come with a flat fee that you pay annually, while others charge a percentage of the total account balance. There may also be an upfront fee if you work with a broker to start a 529 plan.

Is a 529 Savings Plan Right for You?

Helping your child save for college and understand managing money after college can help prepare them for the future, but every family is different when it comes to college savings. So, is a 529 savings plan right for you?

529 savings plans can be an effective way to save for college as long as the earnings are used to pay for qualifying education expenses. That being said, ESAs also allow you to contribute up to $2,000 per year, per child, so that may be an option depending on how much you want to contribute. Calculating the cost of living and creating a budget can help you figure out how much you can afford to contribute to a 529 plan or ESA.

Ultimately, everybody has different needs when it comes to saving for college. If you need help deciding if a 529 plan is right for your family, you might consider scheduling a consultation with a financial advisor.

In Conclusion

Now that you have a more detailed explanation of the potential advantages and disadvantages of 529 plans, you are in a better position to evaluate the rest of the savings plan options and make a decision. Alternatives to 529 plans include education savings accounts, UTMA accounts, and UGMA accounts. Each type of investment account has its pros and cons, so it’s important to weigh your options carefully. But whichever you choose, the good thing is you’re starting your child’s higher education journey off on the right foot. That can go a long way.

In the next chapter, we’ll talk more about UGMA and UTMA accounts and how they work.

Save more, spend smarter, and make your money go further

Mint

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