Is a 529 Plan Right for Your Family?

No doubt about it: College is expensive. Right now, the average cost per year is $35,331*. Multiply that by a couple of children and four to six years to complete a degree, and you may feel heart palpitations coming on.

So what’s a family to do to try to pay for it all?

One important savings vehicle is a 529 Plan, which is designed specifically for college and other educational expenses. This is a tax-advantaged plan that can help you grow your savings faster, but there are some important rules to know about before you dive in.

Here’s what you need to know.

529 Basics 

529 plans were launched in 1996 to help families save for college. Though originally designed only to pay for college costs, today you can use 529 earnings to pay for tuition from kindergarten through graduate school. When you contribute to a 529 account, the money is invested and grows tax-free. As long as the money you withdraw from the account is used for qualified educational expenses, you will never be taxed on the earnings. This allows your money to grow faster.

529 plans are sponsored by individual states, and each state has its own specific rules about the plan. You don’t have to participate in the plan sponsored by your own state, but doing so could come with additional benefits, such as a state tax deduction on your contributions. 

Though the details vary by state, there are several major rules to remember when it comes to 529 plans:

• Anyone can open a 529, but you must name a beneficiary. Generally, parents and grandparents open accounts for a specific child. That beneficiary must be named on the account, and withdrawals must be for that beneficiary’s expenses in order to avoid penalties.
• You can change beneficiaries at any time, but it’s best to keep it in the family. Since a 529 can only be used to pay for a single beneficiary’s expenses, you may wish to change who that is. For example, parents may designate a younger sibling when the original sibling has graduated from college. To avoid penalties, new beneficiaries must be a family member of the current beneficiary.  
• You can make penalty-free withdrawals to pay for qualified educational expenses. Qualified expenses include tuition, books, supplies, and room and board. You may also pay for K-12 tuition at a private school as well as apprenticeship costs and up to $10,000 in student loan repayments. 
• If you withdraw 529 money for non-education purposes, you’ll pay taxes on the earnings, plus a 10% penalty.

529 Benefits and Drawbacks

For many families, a 529 Plan is a great way to save money while avoiding taxes. However, some of the rules limit flexibility and may not be a great choice for everyone. It’s always a good idea to weigh the pros and cons before you invest.

Pros: 

• Tax-free growth of your investment.
• Potential for additional tax benefits in your state.
• 529 money is the asset of the person who owns the account, not the beneficiary. This means that it is given less weight when your child fills out their FAFSA to determine financial aid.
• Easy to change beneficiaries to help other children or grandchildren if you have funds left over.
• Many plans are designed with a target year in mind to automatically adjust risk level over time.

Cons:

• If your named beneficiary doesn’t go to college, you’ll need to designate the funds for someone else or take a 10% penalty to access your savings for non-education purposes.
• Likewise, if your child gets a substantial scholarship or you save too much money in a 529 Plan, you’ll need to decide whether to designate a new beneficiary or take the penalty to use the funds for something else.
• If you build college savings at the expense of your retirement, you could be in a precarious position for the future. 

Alternatives to a 529 Plan 

If you’re uncertain about using a 529 Plan and locking your savings into education spending, there are several other ways to save for college. You might consider: 

• A Brokerage Account: This provides maximum flexibility on your investments, and there are no limits on contributions or withdrawals. You will, however, be fully taxed on the earnings each year.
• A Coverdell ESA: Like a 529, a Coverdell ESA is a tax-advantaged plan, but you have more freedom to control how the money is invested. There is an annual contribution limit of $2,000, and eligibility phases out for higher earners.  
• A Roth IRA: A Roth IRA is a tax-advantaged retirement plan, but it does allow you to withdraw funds to pay for college without penalty. This allows greater flexibility in how you use the funds, but if you spend your whole Roth on college, you’ll need other retirement savings to secure your own future. 

It can be a real challenge to balance saving for college and saving for retirement. We can help make sure you’re on the right track! Contact us today for insight on how to develop a comprehensive financial plan that works for your whole family. 

State tax laws and treatment may vary. Earnings on non-qualified distributions may be subject to income tax and a 10% federal penalty tax. Please consult your tax adviser for more information.

*https://educationdata.org/average-cost-of-college