Blog: Pros and Cons of a 529 College Savings Plan
Would you like to start saving for your child’s college? In this article, we will discuss the pros and cons of saving through a 529 college savings plan. If you live in DC, Maryland, or Virginia, we will also cover the ins and outs of the 529 Maryland, 529 DC and 529 VA plans.
What is 529 savings plan?
A 529 college savings plan is an investment account that you can use to save for your child’s college. You can now also use it for K-12 expenses.
529 plans are usually sponsored by states. So if you live in DC, DC has its own 529 plan. There’s also a 529 Maryland plan and a 529 VA (Virginia) plan.
What are the advantages of a 529 college savings plan?
You can always save for your child’s college fund by stashing it in your bank account. But if you do that, this money will not really grow, and you have to pay taxes on the interest.
There are three main advantages of saving through a 529 savings plan.
- You can invest your child’s college savings in stock funds or bond funds. This will give you the opportunity to potentially grow your money faster.
- It will grow tax-free, as long as you use it for education expenses.
- In some states, you can deduct your contributions from your state income taxes, up to a certain amount. So to answer your question of “Is 529 tax deductible,” the answer is yes, if you live in the more than 30 states, including the District of Columbia, that offer this perk. Click here for the list.
Let’s look at how much tax savings you can generate by saving through a 529 college savings plan. In the graph below (from the Journal Financial Planning), we can see that saving through a 529 savings plan enabled the parents to earn more than $29,000 more in investment earnings, compared to a bank account. This assumes that the parents saved $64,000 and they generated a certain investment return in their 529 savings plan. In addition, the parents generated more than $10,000 in tax savings through the plan, for a total benefit of more than $40,000.
Source: Journal of Financial Planning
The 529 college savings plan also offers some flexibility.
- You can use the money not just for tuition, but for other education expenses like room & board, computer, books and school supplies.
- Can be used for graduate school (in case your child gets a full scholarship for college).
- You can change the beneficiary. Let’s say you opened one for your first born. She got a scholarship. You can change the beneficiary to your other daughter. Or you can always opt to get your PhD ☺
What are the disadvantages of a 529 college savings plan?
The main disadvantage of saving through a 529 college savings plan is the money has to be used for education. You can’t change your mind and instead, use the money to buy a Tesla. You can, but you have to pay taxes on the earnings.
If your child chooses not to go to college, or studies abroad in a school that is not 529-accredited, you have to pay taxes on the earnings.
In addition, you may be subject to a 10% withdrawal penalty, if not used for education. Note that the 10% penalty applies only on the earnings.
Where should you open a 529 plan?
If you live in a state that offers tax-deductible benefits, and the 529 investment options are good (funds have low fees), then it may be worth considering.
For example, if you live in DC, Virginia, Maryland, or Colorado, your 529 contributions are tax-deductible.
In terms of fund fees, the 529 Maryland investment funds range from 0.06% to 0.55% in fees. The 529 VA (Virginia) funds range from 0.09% to 0.72%. The 529 DC funds range from 0.15% to 0.74%. The lower the fees, you get to keep more of your money.
If you live in a state that offers no tax-deductible benefits (such as California), or if your state offers tax incentives but the fund options are not good, you can shop around among other 529 plans.
Need help with deciding on your 529?
A fiduciary financial advisor can help you decide whether setting up a 529 college savings plan is right for you. The financial advisor can help determine which 529 plan would be best to use, and which combination of 529 college funds are most attractive. A fiduciary financial advisor can also run the numbers, so you know how much you need to contribute each month, so your daughter or son can go to the college of her or his choice.
Schedule a FREE 30 minute discovery call with one of our financial planners, to help you plan for your child’s dream college today!
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