Financial Wellness @ Work

Pros & Cons of a 529 College Savings Plan for Your Kids

Figuring out how to pay for your child’s college education can be overwhelming. The cost for one year of school at a public university is over $17,000 and is nearly $40,000 at a private school – and that doesn’t even include the price of room and board. Counting on scholarships to cover college costs is foolhardy and the availability of student loans (especially a loan with a good rate) is not guaranteed.

Perhaps the most common vehicle to save money for college is the 529 college savings plan. But just because everyone’s doing it doesn’t necessarily make it the best choice. Consider the following to determine if a 529 plan is the right savings plan for you:

Pros

  1. Receive a Tax Break. On a federal level, contributions are taxed, but your 529 grows tax-free, and distributions for qualified education expenses are also non-taxable. Plus, many states allow you to deduct all or part of your contributions if you invest in your state’s 529 plan. Investigate multiple plans to find out which tax advantages are available.
  2. Contribution Limits Are High. Just about anyone is eligible to open a 529 plan, and the contribution limits are high. Individual limits may vary by plan, but on average they’re around $250,000.
  3. Enjoy Limited Flexibility. You choose the funds you want to invest in, but you can only change these investments once per year. Individual plans may further limit that frequency, however. Also, you are not committed to stay in any one particular 529 plan and can roll over funds to another 529 if you prefer.
  4. Contribution Requirements Are Low. With some plans, the initial contribution requirement is as low as $25.
  5. You Can Enroll in Another State’s Plan. You’re not limited to using your state’s 529 plan. Just because you live in Georgia, for example, does not mean you can only choose Georgia’s 529 plan. In most cases, you’re able to invest in any state’s plan, though you may give up some tax advantages by doing so.
  6. You Can Change Beneficiaries. When you set up a 529 plan, you do so for the benefit of your child, thereby naming him or her as the beneficiary on the plan. However, if that child does not use all the funds in the plan or does not go to college, you can easily change the beneficiary to another child or relative so that they may use the funds for higher education.

Cons

  1. Penalties for Non-College Expenses Are Steep. If your child does not attend college, you could face stiff penalties. On 529 funds withdrawn for non-college expenses, you must pay income tax plus an additional 10% penalty on the earnings.
  2. Your Retirement Savings Could Suffer. The choice between whether to save and invest money for college or your own retirement is not an easy one to make. After all, you can’t take out loans for your retirement, but in most cases, you can for your child’s education. Plus, that education should lead them to earning an income with which to pay back those loans. One popular compromise is to invest in a Roth IRA, which allows you to withdraw contributions at any time tax-free and to withdraw earnings for qualified education expenses penalty-free – though you do have to pay income tax on those earnings.
  3. Options Are Limited. Most 529 plans only offer between 20 and 30 mutual funds to invest in. On the other hand, if you invest in a regular taxable account, you have a virtually unlimited number of options from which to choose.
  4. Investments Aren’t Guaranteed. Just like any market investment, risk is involved. You can lose some or all of your money depending on market fluctuations.
  5. Financial Aid Eligibility Is Affected. Funds in a 529 plan are treated as a parental asset in financial aid calculations, thereby reducing your child’s ability to get financial aid for college. That said, 529 plan assets do not impact eligibility as much as any assets owned directly by your child.

Final Thoughts

While some parents opt to encourage their children to study a trade or explore occupations that don’t require a college degree, many still see a traditional college education as being vital to their children’s success. In this case, choosing the right vehicle can go a long way toward maximizing your college budget.

A 529 savings plan is most appropriate for parents who feel confident their child will attend college, especially if they have more than one child. In this case, even if both children don’t attend, the child who does can make use of 529 funds and avoid hefty penalties on withdrawals for non-college expenses.

What are your thoughts on 529 plans?

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