What is a 529 College Savings Plan and Is One Worth It? -

Who doesn’t dream of sending their child off to college? While public and private education have both become more expensive over the years, there are more options available to parents today meant to help them get their child off to school.

A 529 plan is just one of the means through which a parent can preemptively mitigate the cost of their child’s college career. There are some downsides to these plans, however, that may make them more hassle than they’re worth.

What is a 529 Plan?

A 529 plan is relatively new in the financial support scene. Established by Michigan Education Trust in 1986, these plans have a history of less than 40 years of sending students to college. Nowadays, 529 plans are not the only prepaid tuition plans on the market, but they are among the most well known.

In general, 529 plans are college savings plans offered to families by banks that provide students with the funds to attend college and families with tax benefits. There are two types of 529 plans, including:

College savings plans – If you want to invest in a college savings plan, you can request that your after-tax contributions in stock market investments are set aside for your child to access at a later date. The amount of money you have affiliated with this plan will vary based on the state of those investments, meaning that while there’s not as much security involved, you will be able to provide your child with substantial support should the market be in your favor. In this way, college savings plans work like many banks’ retirement programs, allowing those investing parties to step outside of their means.
Prepaid tuition plans – If you’re looking for a more reliable plan, you can invest in a prepaid tuition program. These programs allow you to pay down the cost of tuition at a public college either in your state or somewhere else in the United States. You can speak with representatives at your local bank to convert these funds into tuition for private colleges as well.

Regardless of which plan you pick, you’ll be expected to meet monthly minimal contributions to your plan in order to keep it open. You can, of course, add more to the plan than this minimal contribution, but how much you want to add is up to you. Note that other family members can contribute to these funds as long as you give them access and permission to do so.

Any 529 plan can be linked to the Upromise rewards service. Earn a $25 bonus when you connect a 529 account to your Upromise profile.

529 Plans Across the United States

Every state in the United States has some version of a 529 plan, though none of these plans are bound by the states they’re founded in. You’re not required to make an account at the beneficiary’s home state.Different state’s qualified tuition programs allow families living in Arizona, for example, to create either a college savings plan or a prepaid tuition plan within their state and send their child to a college in Oregon without facing any financial consequences. Similarly, families living in Oregon can create a 529 college savings plan in Arizona and then send their child to a college in Illinois.

The versatility of the 529 plan is one of its assets. This doesn’t mean, however, that the plans are flawless. In general, you can count on a 529 plan of either nature to cover your child’s:

Tuition
Fees
Books
Supplies
Equipment
Computers

Room and board payments are not guaranteed as part of any 529 plan. You’ll need to speak with a representative at your local bank to determine your prepaid plan’s eligibility ahead of time.

The good news, however, is that the earnings you place into a 529 plan are tax-free. Your child can withdraw those earnings without facing state taxes to attend to college expenses.

What Happens to 529 if a Child Doesn’t Go to College?

The thing about children is that no matter how well you plan or what kind of safety nets you set, they’re always going to do something you don’t expect. Your children may choose not to go to college, for example, even after you’ve spent years saving up for it.

This isn’t a bad thing! You can not only support your child if they choose not to go to college but also take advantage of the funds that you have in your 529 plan. If it turns out that you don’t need your 529 plan, you can instead:

Change the account owner or beneficiary to another family member who may be able to use the money later down the line.
Pursue higher education yourself by making yourself the beneficiary.
Apply the funds towards an variety of apprenticeship programs.
Transfer the savings into a 529 ABLE account for a qualifying family member living with disabilities.
Remove up to $10,000 for K-12 tuition without that income-generating taxes or withdrawal penalties.
Repay up to $10,000 in student loans.

When is a 529 Plan a Bad Idea?

You also have the option, should your child choose not to go to college, to withdraw the money in a designated 529 plan. Doing so, however, can be costly. If you choose to withdraw the money in one of these plans without intending to use that money to pay for some manner of affiliated educational expense, you’ll be expected to pay 10 percent of your withdrawal in bank fees. You’ll also be expected to pay federal income taxes as well as state income taxes on your withdrawal come tax season.

The only way you can get out of making that kind of payment is if:

The beneficiary designated on the 529 plan receives a tax-free scholarship from the institution they choose to attend.
The beneficiary designated on the plan decides to attend a U.S. military academy.
The beneficiary designated on the plan passes away or otherwise suffers a disability that prevents them from attending college.

What Are the 529 Plan Tax Advantages?

Even if you’re not sure whether or not your child is interested in going to college, creating a 529 investment account can be a good idea. These accounts are among the most versatile savings options available to parents to date. They come with myriad federal income tax benefits, and you do have the ability to withdraw the money therein even if your child opts not to go to college.

Can I Lose Money in a 529 Plan?

You will not lose money if you create a 529 plan. While, should your child opt not to go to college, you will have to pay a percentage of your account earnings, you did have the option to list those losses on your tax return to use as a tax deduction prior to 2018. Now, courtesy of the Tax Cuts and Jobs Act of 2017, no one in possession of a 529 account may write off their losses until after 2025. Instead, if you’re looking to save money when faced with a non-qualified withdrawal fee, you can transfer your savings into a new 529 plan with a separate account owner.

FDIC-insured options within 529 plans are also a available for families who are risk-averse. Parents and grandparents who witnessed their retirement accounts get wiped out by the Great Recession may be hesitant to leave their child’s education fund at the mercy of volatile stock and fixed-income markets.

What are alternatives to a 529 Plan?

If you’re reluctant to take on a 529 plan, there are some financial options available to you that can help you save money for your child’s future education. These include:

Coverdell Education Savings Accounts – Coverdell Education Savings Accounts were used prior to the creation of 529 plans. These accounts and the savings therein could provide students with funding both prior to college and after college, though with few of the benefits of a 529 plan. For starters, the holder of a Coverdell Education Savings Account will not be able to deduct the savings contributed from their taxes. Contributions are also limited to $2,000 per year, and there is a limit on how much you are able to put away.
Uniform Gift to Minors Act – Among your investment options, you can choose a custodial account. While these plans, like Coverdell Education Savings Accounts, are not tax-deductible, they do not have the same limitations as those initial accounts. You will also need to report these gifts on a student’s FAFSA, meaning that a student’s ability to accept financial aid may be affected.
Roth IRAs – You’ll most often find mention of IRAs when considering your plans for retirement. However, that’s not all these accounts can be used for. Roth IRAs also bear purpose as a college savings account. Unlike when using a traditional IRA, no account holder will receive a deduction on their taxes for their savings. However, withdrawals will be tax-free regardless of what you or a recipient choose to use them for. That said, contributions to these accounts are limited to $6,000 a year until the holder turns 70 years old or older, at which point the limit rises to $7,000.

And of course, some families just set aside funds in regular savings accounts at their bank or credit union. Keep in mind that savings accounts typically accrue very little interest (not nearly enough to keep up with the pace of inflation), however some of the best savings accounts do come with great sign-up perks or cash bonuses. You can put those bonus funds into a higher return savings or investment vehicle, and use the savings account as an easy-access rainy day fund for yourself.

Does Having a 529 Plan Hurt Financial Aid?

There is a chance that accepting contributions from a 529 plan may impact your child’s ability to receive financial aid. When you’re filling out the Free Application for Federal Student Aid, for example, you will have to note utilized 529 plan assets on your application. That said, these assets will be considered parental assets as opposed to student assets. In turn, they will not be considered when FAFSA calculates expected parental contributions.

Note that 529 plan accounts owned by a child’s grandparents or another appropriately affiliated relative will need to be listed on a student’s FAFSA. Upon distribution, these assets will count against the aid that student may receive from the federal government. Specifically, these withdrawals count as student income, meaning the student will have a higher EFC upon filing their annual FAFSA.

Who Can Contribute to a 529 Plan?

While it is most often a student’s parents who build up that student’s 529 plan, they are not the only party with the opportunity or right to do so. While the parents will remain in charge of the account, all related family members and even some friends have the right to contribute to this manner of account. As mentioned, parents must, at a minimum, contribute a base percentage to an existing 529 plan every month. From there, however, they have the opportunity to accept checks or cash payments from relatives designed to help their child afford a college degree.

What’s the Validity of Tax Benefits in a 529 Plan?

If you’re a taxpayer who wants to start putting money aside to help your child go to college, you have the option of investing in a 529 plan. However, before you open an account like this up, remember that your child will grow up one day, and they may have plans that are different from your own. Pulling money out of a 529 plan isn’t impossible, but it may be costly later down the line. Those plans that rely on the stock market can often be unreliable as well.

In short, be sure to discuss the validity of a 529 plan with either a banking representative or a legal professional before you open one up. The better prepared you are for the downsides of these plans, the more effectively you can prepare for both your and your child’s future.

For additional information regarding 529 accounts for your child, you can reach out to a financial advisor in your area.

Any 529 plan can be linked to the Upromise rewards service. Earn extra $25 bonus when you connect a 529 account to your Upromise profile.

What is a 529 College Savings Plan and Is One Worth It?