The Pros and Cons of Investing in a 529 Plan for College
If you are a parent of a child who may be heading to college in the future, it is likely that you have thought about how to pay for their tuition. But paying for college is no small feat—with tuition rates constantly rising, college is a huge investment. One of the best ways to be prepared for the cost of college is to start saving early. While there are many options available for savings plans, one you may consider is a tax-advantaged 529 plan. Here are the pros and cons of investing in a 529 plan to help you make the right decision for you and your family.
Pro: Tax Advantages
One of the biggest advantages of investing in a 529 plan for your future college student is that the money will grow tax-deferred, and distributions will be tax-free if they are used for college tuition or related expenses. These expenses may include room and board, books, supplies and other fees, but it is a good idea to check with your financial professional before taking distributions to make sure your expenses qualify.
Many 529 plans also offer tax benefits on the state level. Depending on where you live, you may be eligible for a state income tax deduction or tax credit for contributions to a 529 plan. These plans are the only savings plans that offer tax benefits at the state level.
Con: Penalties for Withdraws
As mentioned above, the 529 plan funds can only be used for qualified college expenses. If you take a distribution and do not use it for a qualified expense, you will owe income tax and a 10% penalty on that money. There are certain exceptions to this rule, including if your child gets a scholarship, attends a U.S. military academy, dies, or becomes disabled.
You also may be on the hook for a penalty if you take a distribution before you are ready to use it. Withdrawals from your 529 savings plan should happen in the same year that they are used for expenses. For instance, if you withdraw $10,000 and only use $8,000 to pay for tuition one semester with plans for using the rest to pay for the next semester, you may be subject to a penalty fee.
Con: Limited Investment Options
While there are tax benefits for 529 plans, if you are someone who prefers to have a lot of control over your investments you may want to consider saving elsewhere. Many 529 plans have limited investment options, including static investment portfolios to mitigate risk and age-based portfolios that enable you to be more conservative the closer your child is to college-age. If you are okay with a hands-off approach to investing for your child’s future, this may not be a con for you.
Pro: Flexibility in Other Areas
While there may not be a breadth of investment options, 529 plans do have a lot of flexibility in other ways. You can invest in any 529 plan no matter what state you live in or where your student plans to go to college, which gives you many options to choose from. There is no requirement as far as household income or regular contributions. There’s also flexibility with beneficiaries. If your child decides not to go to college, you can transfer funds to another child or even to yourself if you are thinking of going back to school with no risk of distribution penalties.
Another benefit of 529 plans is their high contribution limits. Most plans have no annual limit and aggregate contribution limits from $235,000 to over $500,000, varying by state.
If you have questions about the specifics of investing in a 529 savings plan for your child’s future, contact us for a complementary analysis and let us help you plan your savings strategy.