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What are the Pros and Cons of a 529 Plan to Save for College?

The most common type of 529 plan is the College Savings Plan. It works like a regular investment account, allowing you to choose various investment options. The growth of your savings is not subject to federal income tax when used for qualified expenses.

While there are a number of benefits for this way of saving for college, there are also a number of hazards.

Some of the pros:

  • Tax Advantages: Perhaps the most significant benefit of a 529 plan is its tax advantage. Earnings in the account grow tax-free, and withdrawals for qualified education expenses are also tax-free at the federal level. You can also receive a state income tax deduction or credit for contributions in many states.
  • Flexibility: 529 plans are flexible regarding who the beneficiary can be. You can use the funds for your child, a grandchild, or even yourself if you decide to pursue further education.
  • High Contribution Limits: 529 plans typically have high contribution limits, allowing you to save substantial amounts for education.
  • Control: As the account owner, you retain control over the funds. You can change the beneficiary, make investment choices, and even withdraw the money (although non-qualified withdrawals may be subject to taxes and penalties).

While this all sounds good, there are also some serious cons to think about:

  • Fees: They have significant fees and penalties for non-educational or ill-time withdrawals. A 10% penalty applies when money in the account is used for something other than qualified educational expenses (room and board, textbooks, necessary supplies). If you overdraw or overestimate your child’s educational cost the penalty would apply to any money not used for qualified expenses. Higher management fees can also detract from the returns of your earnings.
  • Limited Investment Options: 529 plans typically offer a limited selection of investment options. While this can make the decision-making process simpler, it also means you may not have as much control over your investment strategy compared to other types of accounts.
  • Market Fluctuations: Like any investment, the value of the investments in a 529 plan can fluctuate based on market conditions. If the market performs poorly, the value of the account may decrease, potentially impacting your ability to cover educational expenses.
  • They Reduce your Child’s Financial Aid Eligibility: Assets held in a 529 plan are generally considered parental assets for financial aid purposes. While the impact on financial aid eligibility is generally lower than for student assets, it can still affect the amount of aid a student receives.
  • Scholarships: If your child receives an academic or athletic scholarship the 529 plan cannot be used for the difference.
    • You can change the account to help a different child (sibling, grandchild, or another qualified family member according to IRS guidelines)
    • You can use the money for future educational expenses, including graduate school and professional development courses.
    • You can withdraw up to the amount of the scholarship without incurring the 10% penalty on earnings. However, you would still owe federal income tax on the earnings portion of the withdrawal.

There are other options instead of 529 plans. Call me and ask about other ways to save money for college (including a Roth IRA – especially if you’re older than 59 and a half at the time you need the money, a high-yield annuity, or a life insurance policy that grows money income tax free).

And no matter how much you save for college, you should still fill out a FAFSA (Free Application for Federal Student Aid) form and consider all federal aid grants and scholarships available to you and your student.

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