529 College Savings Plans: Facts You Should Know
A 529 savings plan is a tax-advantaged investment account designed to help families save for education. Here’s how it works: You make contributions with after-tax dollars.
You can choose from different investment options. Your choices depend on your risk tolerance and time frame. Many plans offer age-based portfolios that automatically adjust to become more conservative as your child approaches college.
Your investments grow without being taxed. When you need to pay for education, you can withdraw money tax-free. This is true at the federal level if you use the money for qualified expenses.
Let’s test your knowledge with some common myths and facts about 529 plans:
True or False: Saving in a 529 plan significantly reduces financial aid eligibility.
False. Parent-owned 529 plan assets are seen as parental assets in financial aid. They are assessed at a maximum rate of 5.6% in the Student Aid Index (SAI). In contrast, student-owned assets can be assessed at rates up to 20%.
True or False: If my child doesn’t attend college or gets a scholarship, I’ll lose the money.
False. Unused funds can be transferred to another eligible family member, including siblings, nieces, nephews, or even yourself.
If your child gets a scholarship, you can take out the same amount without penalties. However, any earnings will still be taxed. Starting in 2024, certain 529 funds may also be rolled into a Roth IRA under specific conditions.
True or False: I can only open a 529 plan in my state.
False. You’re free to invest in any state’s 529 plan, regardless of where you live. Some states give tax benefits or other perks to residents who pick their in-state plan. So, it’s good to check your options.
True or False: 529 plans can be used for K-12 tuition.
True. Up to $10,000 per year per beneficiary can be used for tuition at private or religious K-12 schools. At the college level, 529 funds can cover tuition, fees, room and board, books, and even necessary technology like computers.
True or False: Only parents can open a 529 account.
False. Anyone—grandparents, aunts, uncles, or even family friends—can open and contribute to a 529 plan for a future student. However, if a non-parent owns the account, it could impact financial aid eligibility when funds are withdrawn.
True or False: Small contributions won’t make a difference.
False. Even modest, consistent contributions can grow significantly over time due to the power of compounding. Encouraging family members to contribute for birthdays or holidays can further boost savings, potentially reducing the need for student loans.
Drawbacks of a 529 Plan
While 529 plans offer valuable advantages for education savings, they also have potential downsides that families should carefully evaluate. Here are seven key drawbacks to keep in mind before committing to a plan:
Risk of Overfunding – If the beneficiary secures scholarships, opts out of college, or incurs fewer education-related costs than expected, leftover funds may be subject to taxes and penalties if used for non-qualified expenses.
Impact on Financial Aid – Since 529 plan assets are considered parental assets, they can influence a student’s eligibility for need-based financial aid, potentially reducing the assistance they receive.
Market Volatility – The value of a 529 plan depends on market performance. If investments decline, so does the account balance, which could affect the funds available for education costs.
Penalties on Non-Education Withdrawals – Using 529 funds for non-qualified expenses results in taxes and a 10% penalty on earnings, limiting financial flexibility if the beneficiary chooses an alternative path.
Restricted Investment Choices – Most 529 plans offer a predetermined selection of investments managed by the plan administrator, leaving little room for personalized investment strategies.
State-Specific Limitations – Some tax advantages, such as deductions or credits, apply only to residents of the state sponsoring the plan. Certain states may also impose restrictions that limit benefits for non-residents.
Fees and Costs – Many 529 plans carry fees for enrollment, account maintenance, and fund management, which can eat into investment returns over time.
529 plans offer flexibility, tax advantages, and a powerful way to invest in a child’s future. Whether you’re starting small or making larger contributions, every dollar saved is a step toward reducing education costs down the road.
Before investing in a 529 plan, it’s essential to weigh these potential drawbacks against the benefits to determine whether it aligns with your long-term education savings goals.
Sources:
https://www.fidelity.com/learning-center/personal-finance/college-planning/dispelling-529-plan-myths
https://smartasset.com/investing/advantages-and-disadvantages-of-a-529-plan
Disclosure:
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.
529 Plan, or "qualified tuition plan," is an investment account that provides tax benefits when the savings are used for qualified education expenses. Withdrawals from a 529 plan account can be taken at any time, for any reason. But, if the money is not used for qualified education expenses, you will incur a 10% penalty and owe taxes on any investment gains.
The Student Aid Index (SAI) is a number the school uses to determine how much financial aid you qualify for. In general, the lower the SAI, the more assistance you'll receive.
