As kids head back to school this August, many people turn their attention to saving for their child or grandchild’s education. A popular way to do that is through a 529 Plan.
Let’s explore what a 529 plan is and its advantages and disadvantages.
What is it? A 529 plan is a tax-advantaged investment vehicle in which people can save for education. The contributions are made with after-tax dollars and grow tax deferred. Upon distribution, any earnings are tax free if used for qualifying education expenses. This money can be used for grades K-12, public and private colleges, technical schools, and much more.
Disadvantage: The assets are subject to the ups and downs of the market, and 529 plans do not guarantee a return.
Advantage: Because the assets are invested, they have a much greater growth potential over time vs. sitting in cash.
Disadvantage: The assets have to be used on education expenses so this investment account is more restrictive than other types in that respect.
Advantage: 529s provide an excellent way to save and invest for education with tax advantages. Even if the original beneficiary does not go to school, the account owner can change the beneficiary to another family member so they are not forced out of the plan and incur penalties and taxes. By changing the beneficiary, the account owner avoids penalties and taxes, and the account can still grow tax deferred.
Disadvantage: If the withdrawals are not used for education expenses for the beneficiary, they could face a 10% penalty + income taxes on any gains.
Advantage: Withdrawals are tax free if used for qualifying expenses for the beneficiary. This includes things such as books, tuition, etc.
Disadvantage: The account is more restrictive in what the assets can be used for.
Advantage: The account owner maintains control of the assets, regardless of the beneficiary. This appeals to many parents and grandparents who want to save for their loved ones but do not want to relinquish complete control of the money to someone at a young age.
As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investors or designated beneficiary’s home state offers any tax or benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds and protection from creditors. The tax implications can vary significantly from state to state.