Pros and cons of 529 plans in college savings and tax breaks


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Given the notoriously high cost of education in the U.S., parents, future parents, or anyone planning to pay for college would be wise to start thinking about saving up sooner rather than later.

And what better time to think about a college savings account than 529 College Savings Day? The so-called “holiday” is observed on May 29 to bring awareness to 529 plans. Officially known under the tax code as Qualified Tuition Programs, 529 plans are tax-advantaged education savings accounts independently sponsored and run by nearly all 50 states and the District of Columbia.

The plans have grown in popularity over the years to an estimated 16 million accounts with an average balance of $25,630 as of the end of 2022, up from around 13 million accounts in 2017, according to the College Savings Plans Network (CSPN). 

Anyone can open and contribute to a 529 plan for a designated beneficiary, and earnings and withdrawals are federal income tax-free as long as the money is used on qualifying education expenses.

But those aren’t all the benefits — here’s a look at the pros and cons for 529 plans, and how to decide if one is right for you.

What can 529 plans be used for?

In the past, families could only use funds from their 529 plans to pay for college, but the list of eligible expenses has grown over the years.

Here are a few other qualified expenses to consider using 529 funds for.

Educational costs from kindergarten through college

Some families elect to use 529 funds before their children reach college age since you can use up to $10,000 per year to pay for kindergarten through 12th grade tuition at private schools.

Unlike college costs, however, your 529 plan funds can only go toward tuition for primary and high school. When your beneficiary heads to college, however, they can spend 529 money on tuition and such expenses as room and board, textbooks, computers and more.

You can also put up a total of $10,000 from 529 plans toward student loan payments for the beneficiary or their siblings. The $10,000 is a lifetime limit per borrower, so even if multiple parties open several 529 plans for a single beneficiary, the total amount that can go toward that beneficiary’s student debt repayment is still $10,000.

Funds from a single 529 plan, however, could go toward the beneficiary and their sibling’s debt repayment, as long as the amount does not exceed $10,000 per borrower.

Trade school and apprenticeship expenses

If your child or beneficiary decides to take a career route other than college, their 529 plan can still come in handy. Funds can be used to cover tuition and expenses, including textbooks, supplies, equipment and fees, for qualifying trade schools and apprenticeship programs. 

Roth IRA rollover

Beginning in 2024, beneficiaries will have the option to roll over some 529 plan funds tax- and penalty-free into a Roth individual retirement account (IRA), thanks to the Secure 2.0 Act, which passed in December 2022.

The 529 plan must be at least 15 years old and rollover funds will still be subject to Roth annual contribution limits, which for 2023 is $6,500. Those ages 50 and older can contribute an additional $1,000. Beneficiaries can roll over up to $35,000 in their lifetime.

Benefits of investing in a 529 plan

Earmarking your money for something specific, like education, can help motivate you to keep saving. But the tax advantages are the main reason 529 plans stand out from regular savings accounts.

On top of tax-free growth, some states allow taxpayers to deduct or get a credit for 529 plan contributions on their taxes. 

“For people who are earning a good wage, eliminating some state tax is beneficial,” Michael Green, a certified financial planner with a background in college and independent school financial aid, tells CNBC Make It. “Putting money into a 529 is a win on multiple levels.” 

You certainly could stash away money for future education expenses in a regular high-yield savings account, but you won’t get any tax benefits.

“There are a lot of opportunities and flexibility within [529 plans] that other savings vehicles may not allow,” Rachel Biar, chair of CSPN and assistant state treasurer for the state of Nebraska, tells CNBC Make It.

However, people sometimes misunderstand that flexibility, Biar says. Contrary to popular belief, you can invest in a plan sponsored by any state and you don’t have to send your beneficiary to college in the state that sponsors the plan.

But you’ll only get the state tax deduction if you use a plan from the state where you live, so it’s a good idea to compare your options.

Additionally, you can change the beneficiary on your 529 plan as many times as you need to, as long as the new recipient is a qualifying relative — which includes siblings, spouses, first cousins, children and more — of the original beneficiary.

Drawbacks of 529 savings plans

One of the main drawbacks of saving in a 529 plan is that you owe a penalty if you use the funds for an ineligible expense. If you do need to withdraw funds or use them for noneducation-related expenses, you’ll incur a 10% penalty and owe taxes on any investment gains.

Additionally, when using a plan to save for college, there is a pervasive idea that 529 plans can hurt your kid’s chances of receiving financial aid. “While there is a small impact, it is not significant,” Biar says.

The Free Application for Federal Student Aid (FAFSA) does take 529 plan savings into account when determining your expected family contribution (EFC), but not at face value.

Parents’ assets — which for FAFSA purposes include all funds in 529 plans owned by dependent students or custodial parents — are assessed at up to 5.64% when applying for financial aid for their child. That means if a student has a 529 plan with $10,000 in savings when they file their FAFSA, their family’s EFC could go up by, at most, $564.

One other consideration some parents dwell on is the question of what if their child doesn’t want to go to college or if they earn a full-ride scholarship. A 529 plan can still be beneficial because it can be used for other costs like books and supplies that might not be covered by scholarships or financial aid. 

Alternatively, there will be the option for the beneficiary to get a head start on retirement saving by moving those funds to a Roth IRA. 

Is a 529 plan right for you?

If you’re planning to pay for education in the future — for your child, your niece or nephew, godchild or yourself — a 529 plan could be a good place to invest. 

“You get the potential for a tax deduction on your state taxes, you’re allocating money for a specific goal that is important to you, you’re putting it into an environment where it can grow without tax and [withdrawals are] tax-free if you’re using it for educational expenses,” Green says.

However, parents may be tempted to prioritize their child’s college fund over their own needs, which Green advises against.

“If you save all of your discretionary money in a 529, you have no money to handle emergencies,” he says. “It makes zero sense to put money into an account that you’re going to be penalized on if you withdraw it.”

But even if you can’t afford to sock away an entire college tuition’s worth of cash, every little bit helps, particularly if you invest consistently over time.

“There is no ‘too little to save,’ especially if you start saving early,” Green says. “If the month that your newborn comes home you open up a 529 and put 10 bucks a month, 100 bucks, or whatever you can afford, you will have more saved for college and you won’t have to work as hard because time and compounding interest will be on your side.”

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