16 Nov Pros and Cons of a 529 Plan
A 529 plan is a financial investment, which is why it is wise to weigh the pros and cons of a 529 plan just as you would any other type of investment.
A 529 plan is an investment in your child’s future education.
Unlike traditional savings accounts, a 529 plan is designed specifically for saving for education.
And parents need to save – college costs are rising at alarming rates.
Check out these statistics from U.S. News representing the rise in college costs over 20 years:
- The average tuition and fees at private National Universities have jumped 144%.
- Out-of-state tuition and fees at public National Universities have risen 171%.
- In-state tuition and fees at public National Universities have grown the most, increasing 211%.
- The total consumer price index inflation increased by around 54% from July 2001 to July 2021.
These numbers clearly demonstrate why parents are saving more for college and researching the pros and cons of a 529 plan.
According to Education Data Initiative, “Americans on average want to save $57,981 for their child’s college expenses.”
That isn’t chump change.
It takes a solid savings and investment plan to save this amount of money on top of saving for your own future.
As of 2021, 30% of saving accounts are 529 plans – the largest majority.
Will you be part of this majority?
One way to determine if this type of education savings plan is right for you is to carefully consider the pros and cons of a 529 plan.
What Are The Benefits of a 529 Plan?
In order to weigh the pros and cons of a 529 plan, you need to understand how a 529 plan works.
A 529 plan is a tax-advantaged saving plan that may be used to pay for qualified education expenses for a designated beneficiary.
529 plans may be used for college tuition, as well as K-12 grade education (such as private school tuition) and apprenticeship programs.
529 plans may also be used to pay for qualified education expenses, such as room and board and computers.
With a 529 plan, the savings grow tax-deferred.
In addition to savings growing, withdrawals from 529 plans are tax-free as long as they are withdrawn for qualified education expenses.
Now, let’s look at the pros of a 529 plan.
529 plans offer a lot of flexibility. There are more than 100 different types of tax-advantaged 529 plans. 529 plans also vary by state.
However, you are not tied to the 529 plan your state offers.
You are allowed to invest in any state’s 529 plan, so you can choose the one that is the best financial choice for your student.
That’s not the only way a 529 plan proves to be flexible.
Since a 529 plan grows as you save, your child will have more flexibility in choosing what college to attend.
If you ask parents for a pro of a 529 plan, most will point out the tax benefits.
Not only does your investment grow tax-deferred, but you also don’t pay taxes on any withdrawals made to pay for qualified educational expenses.
Saving for College explains further, “In most cases, states exclude qualified 529 plan distributions from taxable income, and many states offer a state income tax deduction or state income tax credit for 529 plan contributions. 529 plans are the only college savings plan to offer state tax benefits.”
This is another reason the flexibility of choosing which state 529 plan works best is a major pro.
High Contribution Limits
Unlike other college savings plans or investment accounts, there are no limits on how much you can contribute to a 529 plan annually.
You can contribute up to $15,000 a year before you incur gift taxes or use some of your lifetime gift tax exclusion.
However, according to Saving for College, “There is also an election to contribute as much as $75,000 in one year without generating a taxable gift if the contribution is treated as if it were spread over five years.”
Technically, there is not a yearly contribution limit. You can contribute more than this amount, but you’d have to deal with gift tax issues.
There is not an annual limit, but states have different cumulative contribution limits, ranging from $235,000 to $529,000.
Another pro of a 529 plan is that it may be used to pay for more than just tuition.
One of the perks of a 529 plan is, it can be used to pay for qualified education expenses, including computers, internet access, and software.
However, this only applies to college students where this technology is required.
If the college’s website says something like, “All undergraduate students at ABC University are required to have a laptop computer that can connect to the Internet,” then the money from your 529 plan may be used to cover this expense.
Doesn’t Affect Financial Aid
Some parents hesitate to invest in a 529 plan because they worry it will affect their child’s financial aid.
Generally, this is not something to worry about because FAFSA views a 529 plan as a parental asset.
Saving for College explains, “About the first $10,000 will fall under the Asset Protection Allowance (the exact amount depends on the older parent’s age). Any parental assets beyond that amount will reduce a student’s aid package by up to a maximum of 5.64% of the asset’s value.”
This means, if you have more than $10,000, your student’s financial aid may be reduced by $564.
In comparison with the money you saved and the tax-deferred growth it experienced, this is minimal.
You Can Use for Private School or Middle or High School
One reason why 529 plans are growing in popularity is because of their versatility.
In the beginning, 529 plans were solely for college expenses.
However, beginning in 2017, 529 plans were expanded to include K-12 grade education (such as private school tuition) and apprenticeship programs.
What Is the Downside of a 529 Plan?
We’d be remiss to only focus on the benefits because there are pros and cons of a 529 plan.
Before you jump at the benefits, take time to consider the following disadvantages of a 529 plan.
Have to Use Funds for Education
Let’s say you invest in a 529 plan, and then your child decides not to go to college or earns a substantial amount of money in scholarships.
What happens to the money in your 529 plan?
Technically, the money in the 529 plan must be used for qualified educational purposes.
You have the following options:
#1 Change the beneficiary to a sibling or another family member.
#2 Withdraw it and pay the penalty.
Tax and Penalties
Parents must also be aware of penalties for withdrawing from the 529 plan.
You can withdraw from a 529 at any time for any purpose.
However, if it is not for qualified educational purposes, you will pay a 10% tax penalty in addition to regular income taxes.
You must only withdraw from the 529 plan during the same year you made the qualified educational expenses, or else you face tax penalties.
For instance, the academic calendar goes from August to June, but for distributions, you’d calculate your child’s spring 2021 and fall 2021 semesters together instead of fall 2021 and spring 2022.
Limited Investment Choices
Unlike other investment accounts that allow you to manage them, a 529 plan requires owners to choose from a select group of investment options.
There isn’t as much freedom as those who are knowledgeable about investments and the stock market are accustomed to.
Not every 529 plan is the same. Some 529 plans have higher fees, so it is important to do your research.
529 plan fees can add up, including the maintenance and investment management fees and expense ratio.