We all know college is expensive. In 2019, the average sticker price of an in-state public college education was $10,116, while private colleges average a whopping $36,801. With the ever-increasing price of sending kids to college, more parents than ever feel the need to find ways to save for their children's college expenses.
529 college savings plans' popularity and growth have continued to rise since their creation under the Small Business Protection Act of 1996, but studies still show that most Americans still don't know what a 529 savings plan is. We break down the basic pros and cons of 529 plans, giving you a better understanding of how they work and if they may be the right college savings vehicle for your kids.
What Is a 529 College Savings Plan?
529 plans are tax-advantaged investment accounts that are state or state agency run to save for college expenses.
There are no income, age, or contribution limits to 529 savings plans. You don't have to worry if the account beneficiary doesn't go to college right away; they can use it whenever! Additionally, the beneficiary of the plan can be changed to another family member. This means that, as the account owner, you can transfer it to another family member, including yourself! Parents can feel better about staying in control of the money, too. Unlike UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) accounts, the custodian of a 529 savings plan always stays the owner; it will never switch over to the control of the beneficiary. This means parents can rest assured that their child can't withdraw the money to purchase the Mustang they've been eyeing!
The most obvious disadvantage to 529 plans is that you are limited to withdrawing the money only for college expenses. If withdrawn for any other reason, you may be subject to income tax along with penalty expenses on the earning portions of the account. Luckily, the list of qualified college expenses is vast, including the most recent addition to the list: student loan payments.Since 529 plans are run by states and institutional agencies, a big concern is whether or not the plan that is opened will transfer easily if the beneficiary ends up going to college out of state. In most 529 plans, your choice of college is not affected by the state in which it was opened.
Most states offer a full or partial tax deduction for 529 contributions. Some states even allow a tax credit for the contributions. Account owners can also feel better knowing that the earnings grow tax-free and will never be taxed as long as the money is used for qualified expenses.
Most plans are low maintenance and have automatic investment management options, which means less work and worry on your end. Many 529 plans use target-date funds, which change based on the beneficiary's age and become more conservative the closer they get to college age. These types of funds can be great for the account owner, who wants to be able to "set it and forget it." but it can also be troublesome for those more involved with managing their own investments. Account owners can only make investment changes twice a year in 529 accounts (there is a loophole for this if you switch the beneficiary; then the investment change limit is reset)
529 Plans' Effect on Financial Aid
There is much debate over how a 529 plan can affect a college applicant's ability to receive financial aid. A lot of factors go into the decision-making on FASFA (free application for federal student aid) forms, so it's important to look into each individual case. Since student assets are assessed at higher rates than parents', in most cases it is best to keep the account in the parent's name. However, 529 accounts owned by a grandparent will be counted on the FASFA application as the student's assets, so it will be assessed at a higher percentage.
In my personal opinion, as a former personal banker and mother of two, 529 plans are the best way to save for college, as long as you start early– it doesn't make much sense to open one if your child will be attending college in just a few short years. The best advice I can give people is to act early, set clear goals for the future, and meet with a financial professional to discuss your exact situation.