As a parent, you know how important it is to begin saving for your child’s college education. However, it’s not always clear what the right path is when it comes to saving. That’s where 529 college savings plans come in.
Though a 529 Savings Plan is a great way to begin saving for college, they come with many rules and regulations that can make them overwhelming to navigate. If you’re contemplating opening up a savings account of your own, here are some pros and cons to consider.
What is a 529 Savings Plan?
A 529 plan is one of the parents’ many options for saving their children’s college education. States and educational institutions operate these plans, and they’re designed to help families put aside money for future college expenses. It’s named after Section 529 of the Internal Revenue Code, which created the savings plans in 1996.
Pros of a 529 Savings Plan
One of the biggest pros of the 529 Savings Plan is that you don’t have to pay federal or state taxes on the overall growth of the plan as long as the funds are used for your child’s educational expenses.
Educational expenses include things like tuition, room and board, books, and even transportation. Additionally, if your child earns scholarships or any type of financial aid assistance, you can withdraw the same amount of that money without any penalty.
However, if you end up withdrawing money and not putting it towards educational expenses, there is a 10% tax penalty.
High Contribution Limits
529 Savings Plans differ from Roth IRA accounts or Coverdell Education Savings accounts in that there is a very high contribution limit. The maximum amount you can save varies by state but in most cases ranges from $235,000 to $529,000.
Since they are considered gifts for the beneficiary, they also have a tax exclusion of up to $15,000 per year where you do not get taxed.
Limited Affect on Financial Aid
The 529 Savings Plan helps students make it to and through college. That’s why it has minimal impact on the FAFSA®, even though it’s reported as an asset. The same can not be said for IRA or 401k accounts.
Assets can keep a child from gaining federal financial aid that they don’t have to pay back, such as the Pell Grant or other institutional scholarships.
Choose Where You Want to Invest
529 plans differ from state to state, but a huge bonus is that you can pick which state you want to open your account in. That means you can choose an option that’s more favorable than where you live.
It’s essential to do some research or work with a financial advisor to choose the right option. After all, when it comes to your child’s education, you want to get the most out of it.
Easy to Use
The 529 plans are designed to help families navigate the financial aid process more efficiently. That’s why it’s so easy to sign-up and manage your plan.
You can sign-up online without going to a bank or work closely with an advisor who can guide you through the process. And if you want to open it and contribute without having to think about it every month, you can set up automatic payroll deductions. The investments themselves will be handled by a program manager assigned to your account.
Cons of a 529 Savings Plan
There are several penalties for making withdrawals that aren’t qualified education expenses. In some cases, you may need to double-check that a withdrawal will qualify, so you aren’t subject to the income tax and 10% penalty on earnings within your withdrawal.
State Rollover Penalties
One reason to research which state you want to open your plan in is due to the loss of income you might face should you roll it over to another state in the future.
Income tax deductions and previously claimed credits could be subject to recapture. The last thing you want is to work hard at saving money, only to lose what you’ve gained because you had to roll your account into a new state later down the line.
Less Control Over Investments
Unlike your retirement savings plans, a 529 plan doesn’t allow for a lot of flexibility when it comes to your investment portfolio. In general, they aim for a low level of risk that slowly takes on more risk and shifts assets the closer your child gets to college age.
Unfortunately, a 529 plan protects the owner of the plan rather than the beneficiary. Owners can easily liquidate the plan or change beneficiaries whenever they choose to.
This could be devastating if a parent and child were counting on having that money for college. So, if you’re aware that a family member is starting an investment account for your child, it’s worth knowing they can change their minds at any time.
Now that you know some of the pros and cons of a 529 Savings Plan, hopefully, you can make an informed decision about what will work for you and your family. If you have questions or need any additional financial aid information, reach out to us here at Frank.