"Are 529 plans worth it?"
This is a common question. Fortunately, there's an easy answer: Of all the options available for funding your children's education, 529 plans are by far the most popular and — in many cases — the best option.
529 education savings plans are state-sponsored, tax-advantaged accounts for education expenses. These plans are ideal for parents or family members who want to ensure a child can access a world-class college education without worrying about the cost. At the same time, a 529 college saving plan contains very real tax benefits that may assist contributors in reducing their tax liability.
How to Start a 529 College Savings Plan
Starting a 529 college savings plan differs in every state, and different paperwork requirements and applications will be needed. However, all 529 saving plans will need at least two basic pieces of information:
- An account owner. This person is responsible for keeping an account up-to-date and is usually (though not always) the primary individual who makes deposits. The account owner is also the person who maintains control over the 529 plan. There is no limit on who can contribute to a 529 plan.
- A designated beneficiary. This is the person who the funds from a 529 are invested for. Withdrawals to the account are made to pay for this individual's college expenses. While your child must have a social security number to become the beneficiary, you can open a 529 before a child is born, naming yourself as the beneficiary. When the child is born, you can then change the beneficiary.
You can usually find enrollment information on your State Treasurer website, although some states have different structures for their 529 programs. You can also speak with a financial planner or investment manager to determine the best possible investment vehicles for your 529.
How Does a 529 College Savings Plan Work?
Keep in mind that the person who maintains control over the 529 plan is usually the individual who opens the account plan and you can begin to fund a 529 account as soon as you open it.
529 college savings plans are managed by a financial planner or investment manager. You will deposit into the 529 and make an investment decision with your planner. In this sense, 529 plan management works just like other investment portfolios. Your 529 plan manager will alter your account based on your investment goals, risk tolerance, and the beneficiary's age.
One misconception is that a 529 plan is simply a holdings account, when in reality the main benefit is the opportunity to invest what you contribute tax-free so it can grow faster. The principle of the 529 is invested in various financial instruments, just like any other investment account. However, unlike other savings accounts or investments, the gains on these investments are not taxed.
You can then withdraw from your 529 savings plan, where distributions can cover various college-related expenses, including tuition, living expenses, supplies, and more. In addition, you can use 529 plans for various post-secondary training plans, like apprenticeship programs.
Benefits of 529 College Saving Plans
529 college savings plans allow an individual to achieve multiple financial benefits: They allow you to save for a highly important goal while also ensuring that individuals can do so in a tax-free way that reduces tax liability.
One of the biggest benefits of a 529 plan is that you can open an account with a very low minimum deposit and a few pieces of paperwork. Unlike some investment programs, 529s are easy to administer. They also have no annual contribution limits, although contributions over a certain amount — $17,000 per donor in 2023 — may be subjected to a gift tax. The fact that there is no limit on who can contribute to a 529 plan makes it accessible to anyone, including parents, grandparents, extended family, or more.
The 529 tax plan benefits are significant and one of the most appealing aspects of a 529. As noted by Vanguard, your state may allow you to deduct your 529 from your state income tax. The investment gains are tax-deferred, and your withdrawals are completely tax-free.
Since the 529 program varies from state to state, your state may offer different benefits, therefore, you should contact your home state if you have questions about how the program runs. When in doubt, reach out to your wealth manager for guidance on your specific situation.
While you can unquestionably use other financial tools like mutual funds or a simple savings account for education purposes, the tax advantages of 529 plans in many states make them very appealing. Other options generally incur taxes on the interest or investment gains, cutting into your profits and leaving less money for the intended purpose of funding an education.
As Albert Einstein famously said, "Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it." This maxim applies to a 529 college savings plan as well. The longer you wait to open a 529 plan, the more dollars you will have to put in to fund the same amount of tuition. As such, it pays — literally — to open a 529 plan as soon as possible.
That being said, you have to consider other financial priorities and remember you can't borrow or earn a scholarship for retirement. Each individual has a unique financial situation, and you can pay for a college education through scholarships, financial aid, or a student loan. The possibility of over-funding is real, even with the cost of higher education skyrocketing, as such you should consider how to fund your retirement before investing in a 529 plan, despite perceived urgency.
Unused 529 Savings
Some families have unused 529 savings, particularly if contributions weren't strategized in conjunction with your holistic financial plan. You may experience this circumstance for many reasons, including a change in educational plans or financial aid eligibility.
Fortunately, recently updated 529 plan rules allow multiple potential uses for unused 529 plans. For example, you may use the 529 by rolling at least some of the money into a Roth IRA, transferring it to another child, paying for student loans, or saving the money for future children or grandchildren.
Several of these changes were outlined in the recent SECURE Act 2.0. This specific rule change illuminates a broader point: 529 rules can be changed by the IRS. As such, you should work with your financial advisor to ensure you are monitoring the latest tax code changes and 529 plan rules that could impact your contributions.
How Can an Advisor Help with 529 College Plans?
A financial advisor can be critical in determining the best way to use a 529 plan to ensure that you are adequately preparing for your child's higher education without sacrificing your other financial priorities. 529 plans typically come with multiple investment options, which can give you an array of potential ways to invest in your 529 and ach state's plan operates slightly differently, so a financial planner can help you determine how your plan works and the best way to take advantage of it. Furthermore, different states may have different definitions of college or qualified education expenses. Your financial advisor should help you understand these differences. Finally, the 529 plan tax benefits your state alters may differ from those in another state. As such, knowing how one state's tax plan operates may not be enough for tax purposes.
At Plancorp, we're here to help answer this important question: "Are 529 plans worth it for me?" because the answer is different for everyone. We're elite financial managers with decades of experience working with 529 college plans and ensuring you save for college correctly. As such, we can help you navigate the impact of college savings on your financial portfolio and connect those contributions into your entire financial plan so decisions aren't made in a silo creating ripple effects that impact your ability to reach a different financial goal like homeownership or retirement.
Looking for more information? Check out our cash flow worksheet and learn more about getting the highest benefit from your state's plan.