What is a 529 College Savings Plan?

529 College Savings Plans are state-sponsored tax-advantaged investment vehicles that allow you to save for education expenses. Money invested in the plan is typically diversified across several different assets, such as mutual funds and exchange-traded funds. This can help you gain potentially higher returns over time. However, like any investment, you can lose money if you make the wrong decisions.

The main goal of a 529 is to help pay for college, but thanks to recent changes in the law, you can now also use the account to pay for K-12 tuition and registered apprenticeship programs. If you’re saving for more than one child, you may want to open separate accounts to tailor investments for each of them. If available, you can also take advantage of potential state-tax deduction benefits for each plan.

Who is Eligible for 529 Plans?

Those eligible to use 529 plans include anyone who is a U.S. citizen or resident alien with a valid Social Security number or Individual Taxpayer Identification Number, or ITIN. A contributor can also choose a beneficiary for the account, usually their child, although it can be another family member or themselves. The contributions to the plan are made on a tax-deferred basis and can be withdrawn without federal or state income taxes as long as the funds are used for qualified expenses.

A common misconception is that a 529 plan can only be used for tuition. The money in a 529 plan can be used for almost any educational expense. This includes school supplies, books, technology, and even some entertainment items, as long as they are related to the student’s enrollment in a course of study.

Advantages of 529 Plans

The big advantage of 529 plans is that they allow you to invest your money in order for it to grow over time. In addition, withdrawals for qualified education expenses are tax-free. 

Another benefit of a 529 plan is that anyone can open an account, no matter their age or income level. Additionally, there are no limits on how much can be contributed to a 529 plan. In many cases, the account owner can change the beneficiary if they choose to, which makes the account more flexible than custodial accounts under UGMA and UTMA.

It’s important to remember that while saving for your child’s college tuition is a smart goal, it shouldn’t be your only financial priority. Prioritize paying off consumer debt, building an emergency fund, and investing 15% of your income into retirement accounts like a 401(k) or Roth IRA.

It’s also a good idea to open separate 529 plans for each child, if possible. This allows you to tailor the investments to each child’s needs, make tracking contributions easier, and stay compliant with gift tax regulations. It can also help you take advantage of any state tax deductions if your children live in different states.

Disadvantages of 529 Plans

Some of the drawbacks to 529 plans include a lack of investment options and limited tax benefits. Investors should consider fees and expenses before opening a plan. Also, the funds in a 529 plan are not guaranteed, and the investments may lose value. If a withdrawal is made for non-qualified expenses, investors may incur federal and state income taxes and a 10% penalty.

Another disadvantage is that a parent or grandparent who owns the account retains legal control over the money. This could be an issue if a child decides not to attend college and no longer needs the funds. Changing the beneficiary on a plan is possible, but the account owner must be careful to avoid penalties and income taxes.