Should I Use a 529 to Save for College?

By Financial Advisor Carrie McDonnell | August 25, 2023

Saving for college can be a daunting task. A common question parents have is whether or not a 529 College Savings Plan is the best way to save for their child’s higher education expenses. This article will explore some of the pros and cons to 529s and help parents decide if this type of account is the best option for their child.

529s are a popular type of investment account used for college savings because they offer a number of advantages. Some of these advantages include:

• Tax benefits. Contributions are allowed to grow tax-deferred and may be distributed tax-free when the funds are utilized for qualified higher education expenses.
• Many 529s are low maintenance, offering age-based portfolios designed to adapt the investment approach as your child gets older, starting with a more aggressive strategy and becoming more conservative the closer your child is to college. These portfolios adjust automatically based on your child’s age, requiring little management.
• 529s have high annual contribution limits, allowing an individual to contribute up to $18,000/year in 2024 before contributions are subject to a gift tax. Compared to a Coverdell Education Savings Account, which limits contributions to $2,000/year or Roth IRA, which limits contributions to $7,000/year, 529s provide more capacity and flexibility for saving.

However, there are some potential disadvantages that families should consider before opening a 529 plan:

• 529s count against you for financial aid. In calculations used to determine a family’s financial aid, there are assessable assets and non-assessable assets. Assessable assets count against a family, whereas non-assessable assets do not impact financial aid. Examples of non-assessable assets include retirement accounts, like IRA’s and 401Ks, pensions and home equity (of primary residence). Assessable assets include cash in the bank, brokerage accounts, rental real estate, vacation properties, Coverdell ESAs and 529s.

  It is important to note that the degree to which assessable assets count against you is determined by who owns the account. If the account (brokerage, 529, etc.) is in your child’s name, the college will assess the account at 20% when calculating financial aid. If the account is in the parent’s name, that account will be assessed at 5.64%. In short, when you open a 529 for your child, the account should be in your name with your child listed as designated beneficiary.

• 529s can have limited investment options and high fees. Not all 529s are the same, so depending on where you live, it might be best to look beyond your state's borders for plans that offer lower fees and better investment options. Morningstar rates 529s based on the following criteria and is a helpful resource for identifying the best 529s:
  • A well-researched asset-allocation approach
  • A robust process for selecting underlying investments
  • A well-resourced and experienced investment team
  • Strong, stable, and engaged oversight from the state
  • Low fees
• 529s have strict rules, which, if not adhered to, could trigger a penalty. The most important rule is that 529s have to be used for qualified expenses. Qualified education expenses include tuition and fees, room and board, textbooks and computers. If you spend 529 funds on non-qualified expenses, the distribution may be subject to income tax and a 10 percent penalty on the earnings portion of the withdrawal. Secure 2.0 Act has made it possible to move some unused funds in a 529 to a beneficiary’s Roth IRA without penalty (see here). That being said, if there’s some uncertainty about whether your child will be college bound, a family might prefer using a regular taxable investment account to avoid the additional restrictions of 529s.

Overall, 529s can be a great option for saving for college for most families. Picking a plan that offers a variety of low cost investment options and understanding how these accounts work, how they should be set up and for what type of expenses they can be used is critical for success.

https://www.bankrate.com/investing/529-plan-disadvantages/
https://www.morningstar.com/personal-finance/morningstar-529-ratings-top-plans-what-they-offer