Saving for college expenses can be difficult and takes a lot of time. Many choose to save through a 529 plan to make the process easier. But is a 529 plan worth it? And is it a good idea for you?
Most American parents aim to save just over $55,000 for their children’s college expenses, and 529 plans make up 30% of college savings accounts.
We’ll explain the basics of the 529 plan system as well as where to open an account, and the 529 withdrawal rules. We’ll also go over the pros and cons of 529 plans. Then you can make an educated decision about your child’s education savings.
What is a 529 plan?
A 529 plan is a type of education savings plan that helps families prepare for future education costs. Also called qualified tuition plans, 529 plans offer tax advantages and savings benefits for those saving for higher education expenses.
Money in the account is generally put into investment funds that could help build savings faster than a savings account alone.
Additionally, the earnings in the account can be withdrawn tax-free if they’re used for qualified education expenses. The potential for tax savings makes a 529 plan an attractive method for budgeting expenses for college students.
Who are 529 plans for?
Anyone can open a 529 plan. After opening an account, any money you put into it is meant to be used for education costs for the named beneficiary on the account.
Generally, parents and grandparents are the owners of the account, and their child or grandchild is the beneficiary.
However, a big benefit of 529 plans is the ability for anyone to contribute. This makes it easy for family and friends to add money to the account (which can be one of the best 18th birthday ideas) or they can also add money for holidays.
Where to open a 529 account
Most 529 plans are administered by states and their agencies. Every state and Washington, D.C., offer at least one form of a 529 savings plan. Some educational institutions also sponsor 529 plans of their own.
You can choose to open an account from any state, regardless of where you live.
However, residents who open a 529 plan sponsored by their state may receive tax advantages when contributing to accounts.
In addition, some states offer lower fees and administrative costs to in-state residents.
You should consider both in-state 529 plans and out-of-state plans when deciding where to open a 529 account. Be sure to weigh the potential tax savings from your resident state plan with attractive benefits from other states.
You can look up and compare your state’s plan with the College Savings Plans Network search and compare tool.
For example, if your state offers aggressive tax savings on state income tax by using your state’s 529 plan, it may make sense to use this plan.
If, however, your state doesn’t offer tax benefits through its plan, you may want to choose a state plan with better investment choices.
How to open a 529 education savings account
Opening a 529 plan is usually as simple as finding the state’s plan administration website and filling out a form.
Plans sold directly by their administering state are known as “direct-sold” plans, or you may also choose to work with a financial advisor through an “advisor-sold” plan. Advisor plans still work with state 529 programs, but you’ll generally leave the day-to-day management of the account to your financial advisor. Advisor plans also usually have standard investment planning fees.
What are the pros of a 529 plan?
Is a 529 plan worth it, and what are the important pros and cons of 529 plans? When choosing any type of savings or investment account, you’ll want to consider the benefits and disadvantages. Let’s take a look at the advantages of opening a 529 plan.
Potential for significant tax benefits
By far, the biggest benefit of a 529 plan is the potential for tax savings. Depending on your state, you might be able to save money on state taxes by contributing to your resident state’s plan.
Many states offer tax deductions or credits for contributing residents. Colorado, for example, lets residents filing single tax returns deduct up to $22,700 per beneficiary for the 2024 tax year, according to College Invest. It’s worth noting that there are no federal tax deductions and no credits for investing in a 529 plan.
However, you can still experience great tax savings even if you open a plan outside of your state. Funds you earn in a 529 plan grow tax-free, so you won’t have to pay taxes on the earnings in the account. This tax deferment helps your money grow faster, as you won’t have to pay taxes on investment earnings while the funds are in the account.
When it is time to withdraw money from the account, you might still get to take it out without paying taxes on it. You can withdraw money from a 529 plan for use toward a qualified education expense tax-free.
Generally, qualified education expenses include things like college or trade school tuition, textbooks, and required class supplies.
Flexible education savings
A 529 savings plan gives you flexibility in addition to tax benefits. Anybody can open a 529 account, regardless of income, and name a beneficiary to their account. You can even name yourself as the beneficiary to your account to start saving as soon as possible.
The beneficiary you originally choose isn’t set in stone, either. You can change the beneficiary on your account to better fit your financial plans.
For example, you open an account for your first child and then start wondering, “Should I have another baby?” You choose to have a second child, and your firstborn receives a large scholarship to college. You no longer need all of the money in the 529 account for their education expenses.
You can change the beneficiary on the account to your second child without penalty. Now, your second child has access to the funds in the account to cover education costs.
Easy to set up and maintain
I personally like the idea of this plan because you don’t have to do a lot to manage a 529 savings plan. Once you open the account, you can usually “set it and forget” if you want to, which is a big plus when considering, “Is a 529 plan worth it?”.
Most plans let you assign automatic contributions, such as a monthly transfer of money from your checking account into the 529 plan.
In addition, most 529 plans offer targeted investment options based on your child’s anticipated college years.
While targeted investment funds lower the number of investments you have access to in the account, they make it much easier to manage your 529 plan money. Targeted investment funds generally use your child’s age or estimated college entrance year to create a mix of investments that fit the timeline to create a risk profile for your needs.
As your child gets older, the plan automatically readjusts investments in the fund to better meet current needs.
For example, a newborn has approximately 18 years before they head to college. A target fund for this child might include riskier investments with the potential for higher earnings because any losses would have years to correct themselves.
High contribution limits
Contribution limits for 529 plans are very high.
Many of these limits are upwards of $200,000 or more, according to The College Investor, meaning most families won’t fear hitting the limit.
What are the cons of a 529 plan?
Although 529 plans have a lot of benefits, they also come with certain drawbacks. Get to know the downsides of a 529 plan to better understand if a 529 plan is worth it for your family.
Can only use funds for education without incurring penalties
A 529 plan can help you save up significant funds for your child’s education. However, the funds can only be used for certain educational expenses.
If you decide to use the funds in a 529 account for non-education costs, you’ll have to pay taxes on the earnings. Using 529 funds for non-education expenses negates the tax-free benefit of the account.
In addition, you’ll also pay a tax penalty for withdrawing the funds without using them for education expenses. This penalty could cut into the earnings you’ve made through investments.
Drawbacks to state tax benefits
Not all state 529 plans offer the same types of tax benefits. Most give residents who use their plans a tax deduction or credit for contributions.
If you live in a state without income tax, however, you won’t receive the benefits of someone in a state with income tax. Since those in non-income tax states often pay higher property or sales taxes, a state 529 plan may not be the best fit.
Additionally, you should consider your future plans before committing to a 529 plan.
Say you open a 529 plan in your current state to take advantage of the state tax benefits. Your career, however, takes you to a new state within a few years. If you change your 529 plan, this could affect your investments, fees, and taxes.
Limited individual investment control
Having a low-maintenance account can be a big benefit for some parents — and a major drawback for others. Most 529 plans have a limited number of set investment options for your funds.
If you’re a hands-on investor, this limit on your control over your investments could be frustrating.
Without self-directed fund options, you have to accept the investment choices of the plan.
Instead of a 529 plan, you may want to consider opening custodial accounts or a brokerage account to use the money for education expenses. You may not get the tax benefits of a 529 plan, but having control of individual investments could lead to potentially higher returns.
Potentially high fees
Almost every 529 plan has administrative and investment fees. These fees help cover the cost for the state agency or institution to run and manage the plan. Choosing an advisor-directed plan also generally increases the amount you’ll pay in fees.
As you’re comparing your state plan to other plans, be sure to carefully consider the costs of the plan. Plans explain their fee structures and the fees you’ll pay for certain investment types in the fine print of their offerings. Going over the potential fees of a plan will help you determine if a 529 plan is right for you.
Expert tip
A 529 plan is a great way to save for future education costs for many families. This is because it offers flexible education savings with nearly no contribution limits, all while offering a done-for-you approach to investing.
That said, I recommend doing your research specifically around the tax benefits for different state plans a well as the associated fees. This will help you make an informed investment decision for your 529 account.
Is it possible to lose money in a 529 plan?
Yes, you can lose money in a 529 plan. When you learn how to start investing, there’s always a possibility you’re putting your money at risk.
529 plans are often called savings accounts, but they are almost always used for investing money in the stock market. Investments in a 529 fund could potentially lose money, just like any other investment. This might leave you wondering: is a 529 plan worth it if you could lose money?
The good news is that many 529 plans use a low risk tolerance to determine their fund allocations. Low risk tolerance means your plan puts your money into funds that have historically lower chances of losing money, though the potential is still there.
What happens to 529 if the child doesn’t go to college?
If your child doesn’t go to college, you can use the money for other education costs. Many parents mistakenly assume they’ll have to pay penalties on withdrawals if their child chooses not to attend college, but 529 funds aren’t only for traditional four-year university costs.
Other ways you can avoid paying taxes and penalties on 529 withdrawals if your child doesn’t go to college include:
- Switch the beneficiary to another family member who is attending college or another higher education program.
- Use funds for trade school tuition or a two-year program.
- Cover the cost of K-12 private school tuition.
- Use up to $10,000 to pay off student loans.
How do I withdraw my money from my 529 without penalty?
You can withdraw money without penalties by using it for qualified expenses. Any money you withdraw from a 529 account to use toward qualified education expenses for the beneficiary is generally tax and penalty-free.
Most people know that college tuition is a qualified expense, but qualified expenses might also include:
- Tuition and fees for both college and vocational or trade schools.
- Up to $10,000 per student in tuition and fees and elementary and secondary schools.
- Up to $10,000 toward student loan debt.
- Room and board, including off-campus housing up to on-campus housing costs.
- Food and meal plans.
- Textbooks and required class supplies.
- Computers, so long as they are a requirement for students.
There are many different ways to use funds from a 529 in a qualified withdrawal.
It’s important, however, to be careful when you withdraw funds to not overdraw and to know the 529 withdrawal rules. The money you withdraw from the account must go directly to the cost of higher education. Waiting too long to pay a bill or holding funds for a future expense could lead to paying penalties.
For example, say your child’s yearly tuition is $10,000, which the university bills per semester in $5,000 increments. You would want to avoid withdrawing the full $10,000 at the beginning of the year to pay the tuition bill to avoid paying a penalty on the $5,000 in funds for the second semester tuition bill.
Instead, you should withdraw $5,000 when the first bill comes in and the additional $5,000 when the second bill arrives.
How many times a year can you withdraw money from a 529 plan?
There is no limit to how many times a year you can withdraw money. While you should be careful when you withdraw funds from your 529 account, the good news is you can make unlimited qualified withdrawals from the account. Making more withdrawals throughout the year might also make it easier to keep track of which withdrawal was going to certain expenses.
What amount of time does money have to be in a 529 before you can take it out?
There are generally no restrictions on how long your money has to be in a 529 account before you can withdraw it.
Some states and individual plans, however, may have requirements on how long the account must be open before making a withdrawal. Be sure to check with your plan and the 529 withdrawal rules to see how long the account must be active before removing funds to avoid fees.
Education savings account vs 529: Is a 529 better than a savings account?
A 529 and an education savings account are comparable, but one isn’t better than the other.
State 529 plans aren’t the only savings account for college expenses.
The most common alternative to a 529 plan is a Coverdell Education Savings Account (ESA). Like 529 plans, ESAs help parents save for college expenses for their children.
An ESA is very similar to a 529 plan. Both accounts let you save and invest funds for the college expenses of the beneficiary — which both types of accounts let you change. And just like 529 plans, ESA accounts let you withdraw earnings for the account tax-free if the money goes to qualified education expenses.
Differences between an education savings account and a 529b
However, there are three main differences between an education savings account vs 529 plan:
- ESAs give you more control over your investments, letting you invest in mutual funds, stocks, and bonds.
- Unlike 529 plans, ESAs have annual contribution limits as well as upper-income limits.
- 529 plans don’t have age restrictions for beneficiaries, while money in an ESA must be used or the beneficiary changed to a younger family member by the time the first beneficiary turns 30.
Either a 529 or a savings account could work for you. In general, an ESA has more restrictions regarding contributions and timeline for use.
This might make it seem like a 529 plan is the best option, but that’s not always the case. The ability to mostly self-direct your investments in an ESA could make it the better choice for some parents.
Other alternatives for college savings
Other alternatives include custodial accounts for your children. In a custodial account, you are the owner of the account for the benefit of your child until they turn 18 (or 21 in certain states). After they come of age, the account moves into your child’s full possession.
Wondering if a 529 plan is worth it? Both ESAs and custodial accounts could be a good alternative if you feel a 529 plan isn’t for you, such as if you move states often or want to have more control over your investments.
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Is a 529 plan worth it for education planning?
Generally, we at Clever Girl Finance believe a 529 plan is an excellent way to save for future education costs. Many families find the ease of opening and maintaining their accounts — along with the tax savings — to be worth it to save for college.
If you’re considering opening a 529 account for your child or grandchild, we recommend considering these questions to help you decide if it’s worth it:
- Do you have other education savings in place?
- Do you have a backup plan for the funds if the child doesn’t go to college or doesn’t need the funds, such as securing a scholarship?
- Will you need the funds for other types of expenses outside of education costs?
After considering these questions, you should have a clearer view of whether or not a 529 plan is worth it for your family.
Whatever you decide, it’s always a good idea to plan ahead for your child’s future by saving for education, regardless of the type of account you choose. It is also equally important to consider your retirement savings and other investing goals, so you can create a healthy money story for yourself and your family.
