Pros and Cons of 529 College Savings Plans

Some say that 529 college savings plans are the best thing to ever happen to college planning. Others say the cons far outweigh the pros, and they aren’t worth it.

Who’s right?

Like any investment, there are advantages and disadvantages to setting up a 529 college savings plan. Before we talk about whether they’re awesome or abysmal, let’s define what it is we’re talking about.

What is a 529 College Savings Plan?

A 529 college savings plan is an account used to save for college costs, as well as K-12 tuition. Nearly every state has a 529 college savings plan available, and you don’t have to live in the state, or go to school in the state, in order to invest in their plan. So, you could live in Kentucky, invest in a 529 college savings plan in Ohio, and go to college in Michigan. Almost every state has at least one 529 college savings plan, and there is also a 529 college savings plan operated by a group of private colleges and universities. There are over 6,000 US colleges and universities, and over 400 international colleges and universities, where you can use your 529 college savings plan funds.

What Are The Pros and Cons of a 529?

Now that we’ve defined what a 529 college savings plan is, let’s look at the pros and cons. Because I’m an optimist at heart, we’ll look at the “pros” first.

529 Pros:

• There are some great tax incentives. Contributions aren’t deductible, but earnings in a 529 college savings plan grow federal tax-free, and aren’t taxed when the funds are taken out to pay for education expenses. In 2019, student loan payments and apprenticeship programs are also considered qualified education expenses, and can be paid for with a 529 college savings plan. There may be some state tax breaks too, with over 30 states offering a full or partial tax deduction for 529 college savings plan contributions.
• If you’re the one contributing to the plan, you control the account. The beneficiary has no rights to the funds, so you can be sure it’s used for what it’s supposed to be used for, unlike a UGMA or UTMA, where the beneficiary will have control once they reach legal age.
• You can withdraw money from the account from any time, for any reason, but if it’s not for a qualified education expense, the earnings in the account will be taxed as income as well as have an additional 10% penalty tax.
• They’re easy!! Select the plan you like the best, enroll, and have automatic contributions to the fund out of your account. You can choose an investment geared toward a particular date, which means investments adjust automatically as that date draws near.
• Tax reporting is easy – contributions don’t need to be reported on your federal tax return, and there’s no Form 1099 to report earnings until the year you make withdrawals. Deposits up to $15,000 per individual per year qualify for the annual gift tax exclusion as well.
• They’re flexible. Your contributions can vary, you can change your investment options twice a year, and you can roll over your funds into another 529 college savings plan once a year.
• Everyone can set up a 529 college savings plan – Unlike a Roth IRA and Coverdell Education Savings Account, there are no income, age, or annual contribution limits.
• Parent-owned plans get favorable financial aid treatment, because distributions from a 529 college savings plan owned by a student’s parent or the student themselves aren’t counted as income on the FAFSA form.

529 Cons:

That all sounds pretty good, but what’s the catch? There are a bunch, actually…

• 529 college savings plan funds must be spent on qualified education expenses, in order to avoid tax and penalties. Non-qualifying distributions are subject to income tax, and a 10% penalty, on the earnings portion of the distributions.
• State income tax benefits may be recaptured if you change plans to another state.
• Some plans offer limited investment choices.
• Some plans have high fees.
• 529 college savings plans can hurt financial aid eligibility. If the plan is owned by anyone other than the student or their parent, distributions are counted as untaxed income to the student, and can reduce the student’s eligibility. Assets owned by the student or their parents are considered parental assets on the FAFSA.

Are they great? Not great? I’d argue they’re a bit of both.

Options Other Than a 529 Savings Plans

You could use a Roth IRA instead, which results in the same after tax contribution / tax free earnings treatment as a 529. If you’re over 59 ½ when your child goes to college, you could withdraw funds tax free to cover the expenses; or, if your child doesn’t go to college, it can be used for your retirement. The down side is that there are limits to how much you can contribute, and if you’re not yet 59 ½ when you need the withdrawals, it would be subject to a 10% penalty.

You could invest in CDs, or Certificates of Deposits, which used to be the most popular way to save for college. Some CDs qualify for tax exemptions if you use it for educational expenses, but the interest credited is generally very low.

You could simply invest in the market, after-tax, and target those funds towards education, if needed. The money can be used for anything, which is an advantage over a 529, but there will be tax implications on the investment earnings when the money is withdrawn.

Coverdell Education Savings Accounts are available, but are reserved for those with a low income, and the contribution limit is only $2,000 per year.

Finally, cash-value whole life insurance is becoming more popular. Premiums are paid to a life insurance policy, and the cash value of the policy is available for loans at any time, for any reason. There are no tax consequences to taking the loan on the cash value, and if the insured passes away, the life insurance proceeds are not taxed, and can be used to pay for college expenses.

Monarch Financial Advisors

Is there a “best” college savings plan? It depends on your story, your situation, your finances, and your goals. The important thing is to not miss the opportunities that may be available for you with regard to planning for college, or any other financial goals.

Here’s our story: https://youtu.be/4yJZVCR3Ovo, and here are our thoughts on making sure you don’t miss opportunities. https://youtu.be/UUdqa2aIx1g

We can’t wait to hear your story, so that you don’t miss out on any opportunities to save!

Today’s a great day to start planning for tomorrow!