Pros and Cons of 529 Plans: What You Need to Know

Studies show that college tuition increased by 134% at private colleges and 175% at public universities from 2003 to 2023. So, for many families, these rising costs are making it harder to afford a college degree. To help cover these costs, many families and students start saving for college to help avoid student loans. There are many options you can use to help save money for college. For example, a 529 savings plan is specifically designed to help families save for college. However, this type of plan isn’t right for everyone. Keep reading to learn more about the pros and cons of 529 plans.

Quick Answer: 529 plans are tax advantaged savings plans to help pay for educational expenses.

What Is a 529 Plan?

A 529 plan is a college savings account. It provides parents, grandparents and even other interested parties a tool for saving money for their loved one’s college. In some cases, prospective students may be able to set up their own 529 accounts. The goal of a 529 plan is to save money for several years and then use this money to cover the costs of college. Similar to an IRA account, a 529 plan is an investment account. So, you have the potential to earn interest over the years.

Types of 529 Plans

There are many 529 plans to choose from but only two basic types. The most popular type of 529 plan is the savings plan. With this type of plan, you can use the money you save for tuition and related costs at any eligible university. In fact, you can even use these funds to cover private school expenses for grades K-12.

The second type of 529 account is a prepaid tuition plan. With this type of account, you’re prepaying tuition fees now to cover the cost of attendance later. The benefit is that you can lock in tuition rates well before going to college. The downside is that you’re limited to which universities and colleges the student can attend.

Tax Advantages of 529 Plans

Unlike 401(k) plans, you make 529 contributions with post-tax dollars. However, many states offer tax credits or tax deductions on annual contributions made to 529 plans. The good news is that distributions from 529 plans are tax-free as long as the money is used for qualified educational expenses.

How to Open a 529 Plan

Once you know what type of 529 plan you want to invest in, you should compare various options. Be sure to review all costs involved when making this comparison. If your state offers tax credits or deductions for 529 accounts, you may want to select an in-state plan.

When you’re ready, you can handle the application process yourself or seek the support of a financial advisor who can manage the account for you. If you have concerns about debt collectors having access to your 529 account funds, you may want to speak to a financial advisor about setting up an estate.

Once the account is open, you can make regular contributions to it throughout the year. There are also some 529 credit cards that automatically transfer cashback rewards to a 529 plan.

Who Can Open a 529 Plan?

Anyone can open a 529 plan, including parents, grandparents, aunts, uncles, and other friends and family members. You do have to designate a beneficiary for the funds in the account. Keep in mind that you may face a 10% penalty if you use the money for any purpose other than a qualified expense.

How Much Does a 529 Plan Cost?

The cost of maintaining a 529 account varies from plan to plan. You can expect to pay a variety of fees, including enrollment fees and account management fees. If you work with a broker, you may also incur brokerage fees.

How Much Can I Contribute to a 529 Plan?

There are no annual limits to how much you can contribute to a 529 plan. However, for IRS purposes, contributions up to $17,000 (for 2023) can qualify as a gift. You or a loved one, such as grandparents, can also superfund 529 plans with lump-sum contributions of up to $85,000, but it must be prorated over the next 5 years.

How Many Times Can You Superfund a 529?

There’s no limit to how many times you can superfund a 529 plan. However, you can’t exceed the state’s aggregated limits and shouldn’t contribute more than the gift limit for the year.

How Much to Save for College

According to recent studies, the average cost of college tuition and fees is $10,423 per year for public college and $39,723 per year for private college. If you plan to attend college in state, you may want to view the state’s aggregate limits, which are based on average tuition costs in the state. Once the 529 account balance reaches this maximum level, you can’t make any more contributions.

Who Maintains Control Over a 529 Plan?

The person who sets up the account maintains full control over the 529 account. The owner of the account determines when funds are distributed and the amount of each distribution. The funds must go to the beneficiary, but the owner of the account has the ability to change the beneficiary.

Does a 529 Affect Financial Aid?

When completing the Free Application for Financial Student Aid (FAFSA), you list funds in a 529 account as an asset. If this is a parent’s account, it typically has little impact on financial aid eligibility. However, if the funds come from an account established by a grandparent or other party, it’s treated as cash support. Depending on the value of these funds, these contributions can have a significant impact on eligibility for financial aid.

Qualified Expenses

For distributions for a 529 account to be tax-free, the student must use the funds for qualified expenses. These expenses include:

Tuition
Room and board
Textbooks
Computer
School supplies

How to Withdraw Funds

Funds can be withdrawn at any time by completing the required withdrawal form. Also, keep in mind that only qualified expenses are tax-free. Before requesting a withdrawal, be sure to calculate all your expenses to avoid taking out too much money. You also need to take the money out of your account the same year it will be used.

What If the Child Doesn’t Go to College?

It’s important to understand that you don’t lose your money if your child decides not to go to college. You have two options. First, you can transfer these funds to another beneficiary, such as another child or grandchild. Secondly, you can withdraw the funds.

What Happens to Money Not Used?

If you choose not to use these funds on qualified expenses, you’ll face a 10% penalty and you must pay taxes on all distributions. But, there are some exceptions to this rule. If your child receives a scholarship for college, enters the military academy, or becomes disabled and unable to attend college, you may be able to waive the 10% penalty.

Alternatives

There are a few alternatives to 529 college savings accounts, such as:

Custodial brokerage account. A custodial brokerage account doesn’t provide any extra tax benefits. However, it does give you the freedom to save as much as you want and use it for any purpose.
Roth IRA. A Roth IRA is typically for retirement savings, but in many cases, you can also withdraw funds without penalty for education purposes. However, this account does have annual contribution limits.
Cordell education savings account. The Cordell education savings account is similar to a 529 plan. But, there are strict income eligibility guidelines. Additionally, you can only contribute $2,000 per year per child.
Acorn Early. Help your child start investing money early with Acorn Early to help pay for college.

With a little planning and dedication to maintaining regular savings goals, you can help your child pay for college expenses more easily. Understand the pros and cons of 529 plans before moving forward.