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529 College Savings Plans – The Good, The Bad, and The Ugly


 

As a follow-up to my recent post about saving for college without going broke, I wanted to dive deeper into a popular way many parents and grandparents choose to save: the 529 plan. While doing some research for clients recently, I realized how easy it is to make a bad choice of plan and cost yourself thousands of dollars before your child even goes to college. Below I cover the good, the bad, and the ugly of 529 plans, and list out several links to great resources.

The Good

Tax advantages – 529 plans were created back in the 90s to encourage people to save for college by creating tax advantages for doing so. Investments in 529 plans grow tax-free and all earnings in 529 plans can be withdrawn tax-free if the withdrawal is used for qualified education expenses. In addition, some states’ plans give residents a tax break on the money you put into the plan in the form of a deduction to income. Some states even offer matching funds.

Ownership – Anyone can open and own a 529 plan. That makes it an option for grandparents, aunts, uncles, parents, or complete strangers to save for your child’s education. You can also open a 529 plan for yourself if you plan to attend grad school down the road.

Beneficiaries – There can be only one beneficiary per account, but the owner can change the beneficiary to another family member if the original one decides not to attend college or if there are funds left over.

Flexibility – Money in a regular 529 plan (not the pre-paid tuition variety) can be used at almost any accredited college in the country. You can also use the money for many different expenses besides tuition, like room & board, fees, books and supplies.

Funding – Many plans allow you to set up regular contributions and have low minimum opening requirements. You can also front-load contributions up to 5 years times the annual federal gift tax exclusion in one year. This gives your money more time to grow.

The Bad

Fees – as with any investment, there are fees associated that can vary widely depending on the plan you are looking at. It seems like everyone takes their cut on many 529 options. There are account maintenance fees, asset fees, state fees, and manager fees.

Limited Investments – many plans have a mix of options from age-based portfolios to investments with guaranteed returns. Your options are limited by the plan, however, and you can only change your investment choice twice a year. It’s important to understand your risk tolerance and time horizon because your investment could lose money and you don’t want to come up short if the market dives right before your child goes off to school.

Penalties – If your original beneficiary doesn’t use the money for qualified education expenses, and you can’t/don’t designate a new beneficiary, then your earnings are subject to a 10% penalty when you withdraw them.

The Ugly

Direct-sold v. Advisor-sold – Many states’ plans give you the option of going directly to a website to open a 529 account (or calling a phone number, or fill out a paper application), or you can choose to go to a financial advisor. The reason this is so ugly is that going through the advisor can cost you thousands of dollars more than going direct. The idea is that the advisor will give you good advice if you need it, but there have been cases of advisors recommending out of state plans instead of their own state’s plans just to earn higher commissions. The advisors may also be limited in the plans they can recommend depending on who they are working for. If you need advice, you are much better served going to a fee-only or hourly financial planner who will give you unbiased advice and help you enroll in the direct option that is best for you.

For more information, please check out the links below:

  1.    Learn about 529 plans – intro to 529 plans on the SEC website
  2.    Compare 529 plans - http://www.collegesavings.org/http://www.savingforcollege.com/
  3.    What to look out for – from FINRA