Are 529 plans worth it? are they still a good idea. A college education is a valuable asset for many individuals, but it comes at a high cost. With tuition rates on the rise, saving for college has become a critical financial goal for many families. Enter 529 plans, a popular tax-advantaged savings vehicle designed to help families save for future education expenses. In this guide, we’ll delve into the ins and outs of 529 plans, examining their benefits, drawbacks, and comparing them to other savings options. We’ll also share expert opinions and real-life success stories to help you make an informed decision.
Table of Contents
Types of 529 Plans
There are two main types of 529 plans:
Prepaid Tuition Plans allow families to lock in future tuition rates at eligible public and private colleges and universities.
Education Savings Plans, on the other hand, function more like an investment account.
We have a complete guide on 529 plan along with popular 529 plans, fees and penalties involved.
Benefits of 529 Plans
There are several advantages to using a 529 plan to save for college and to decide if 529 accounts is worth it:
- Tax Benefits: Earnings in a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free. Some states offer additional tax benefits, such as state income tax deductions or credits for contributions.
- High Contribution Limits: Most 529 plans have high contribution limits, allowing families to save significant amounts for college. The limits vary by state but typically range from $235,000 to $520,000 per beneficiary.
- Flexibility: Funds in a 529 plan can be used at any eligible college or university, and even for certain K-12 tuition expenses. If the beneficiary decides not to attend college, the account owner can change the beneficiary to another family member without penalty.
Drawbacks of 529 Plans
However, 529 plans do have some downsides:
- Investment Risk: Education savings plans are subject to market risk, and investment performance is not guaranteed. Depending on the investment options chosen, your account may lose value.
- Limited Investment Choices: Most 529 plans offer a limited selection of investment options, which may not suit every investor’s preferences or risk tolerance.
- Penalties for Non-Qualified Withdrawals: Withdrawing funds from a 529 plan for non-education expenses will result in a 10% penalty on earnings, as well as federal and state income tax on those earnings.
Comparing 529 Plans to Other Savings Options
|Savings Option||Tax Benefits||Investment Choices||Flexibility||Contribution Limits|
|529 Plans||Yes||Limited||High||$235,000 – $520,000|
|Coverdell ESAs||Yes||Broad||Moderate||$2,000 per year|
|UTMA/UGMA||Partial||Broad||Low||None (gift tax applies)|
|Roth IRA||Yes||Broad||Moderate||$6,000 – $7,000 per year|
529 plans provides Limited Investment Options. This typically include a small number of mutual funds or portfolios, such as age-based portfolios that automatically adjust the asset allocation based on the beneficiary’s age, or static portfolios with a fixed allocation of stocks, bonds, and other assets.
Broad Investment Options allows Account holders to invest in individual stocks, bonds, exchange-traded funds (ETFs), and various types of mutual funds, allowing for greater diversification and customization of their investment strategy.
What the Experts Say: Are 529 Plans Worth It?
Many financial experts recommend 529 plans as a valuable savings tool for education expenses. Suze Orman, a well-known personal finance guru, has stated that “529 plans are the most effective way for most families to save for college.” However, others caution against relying solely on 529 plans and recommend diversifying college savings strategies to reduce risk.
Case Studies: Are 529 Plans Worth It ?
In this case study comparison, we’ll examine the outcomes of saving for college using a 529 plan, a high yield savings account, and other college savings options, such as a Coverdell ESA and a UTMA/UGMA account.
- Initial investment: $5,000
- Monthly contributions: $200
- Saving period: 18 years
- Average annual return for 529 plan and Coverdell ESA: 6%
- Average annual return for UTMA/UGMA account: 4% (due to the more conservative investment options)
- High yield savings account interest rate: 1%
Scenario 1: 529 Plan
Using a 529 plan with an average annual return of 6%, after 18 years, the account would grow to approximately $83,780. The earnings would be tax-free when used for qualified education expenses.
Scenario 2: High Yield Savings Account
With a high yield savings account at a 1% interest rate, after 18 years, the account balance would be approximately $53,846. The earnings would be subject to federal and state income tax.
Scenario 3: Coverdell ESA
Investing in a Coverdell ESA with an average annual return of 6%, after 18 years, the account would grow to approximately $83,780. Similar to a 529 plan, the earnings would be tax-free when used for qualified education expenses. However, the contribution limit of $2,000 per year could constrain the growth potential of the account.
Scenario 4: UTMA/UGMA Account
With a more conservative average annual return of 4%, after 18 years, the UTMA/UGMA account would grow to approximately $68,140. The earnings would be subject to the “kiddie tax,” which taxes a portion of a child’s unearned income at their parents’ tax rate.
Flexibility of 529 Plans
One of the key benefits of 529 plans is their flexibility in several aspects, making them a popular choice for families saving for education expenses. In this section, we’ll explore various aspects of flexibility in 529 plans:
- Eligible Institutions and Expenses: 529 plans can be used at a wide range of educational institutions, including public and private colleges, universities, trade schools, and even some international schools. Furthermore, funds from a 529 plan can cover a broad array of qualified expenses, such as tuition, fees, books, supplies, and room and board for students enrolled at least half-time.
- Changing Beneficiaries: The account owner of a 529 plan can change the beneficiary without tax consequences, as long as the new beneficiary is a family member of the original beneficiary. This allows for flexibility in the event that the original beneficiary decides not to attend college or receives a full scholarship.
- Rollovers: Funds from a 529 plan can be rolled over tax-free to another 529 plan for the same beneficiary or a new beneficiary who is a family member. This enables account holders to switch between plans if they find a more suitable option or if their circumstances change.
- No Age or Time Limit: Unlike some other education savings vehicles, such as Coverdell ESAs, 529 plans do not have age or time limits for using the funds. This allows beneficiaries to pursue their education at their own pace, without the pressure of a deadline.
- Contributions and Gifting: Family members and friends can contribute to a beneficiary’s 529 plan, making it easier for families to collectively save for education costs. Some plans also offer gifting platforms that simplify the process of receiving and tracking gifts.
- K-12 Tuition Expenses: In addition to college expenses, 529 plans can also be used for certain K-12 tuition expenses at public, private, or religious schools, up to $10,000 per year per beneficiary.
These various aspects of flexibility make 529 plans an attractive option for families with diverse educational goals and financial circumstances, providing them with greater control and versatility in their savings strategy.
How to Choose the Right 529 Plan
To select the best 529 plan for your needs, consider the following factors:
- State Tax Benefits: If your state offers tax benefits for 529 plan contributions, it may be advantageous to choose an in-state plan.
- Investment Options: Review the plan’s investment options and choose one that aligns with your risk tolerance and investment preferences.
- Fees: Compare plan fees, including management fees and any account maintenance fees.
- Plan Performance: Evaluate the historical performance of the plan’s investment options, keeping in mind that past performance is not indicative of future results.
Vanguard 529 Plan is one such popular 529 college savings plan with low fees and expense ratios.
Conclusion and Final Thoughts
While 529 plans have their drawbacks, their tax benefits, flexibility, and high contribution limits make them a valuable tool for many families saving for college. Before investing in a 529 plan, it’s essential to weigh the pros and cons, compare alternative savings vehicles, and consult with a financial professional to ensure you’re making the best decision for your family’s unique needs. Hopefully this helped you get closer to knowing are 529 Plans Worth It ?
Frequently Asked Questions (FAQs)
What are 2 main benefits of 529 plans?
The two main benefits of 529 plans are tax advantages and flexibility. Earnings in a 529 plan grow tax-free, and withdrawals for qualified education expenses are also tax-free. Additionally, 529 plans offer flexibility by allowing you to change beneficiaries and choose from a variety of investment options.
Should I open a 529 for each child?
Opening a separate 529 plan for each child allows you to tailor the investments and risk level to each child’s age and future education needs. However, you can also open a single 529 plan and change the beneficiary as needed.
Is a 529 worth it for 2 years?
A 529 plan can still be beneficial for a 2-year timeframe, as it offers tax-free growth and withdrawals for qualified expenses. However, in a shorter time frame, it may be prudent to choose more conservative investment
How much should you have in a 529 at age 5?
The amount you should have in a 529 plan at age 5 depends on your college savings goals and the expected cost of education. Aiming to have 25-30% of your total college savings goal by age 5 can help ensure you’re on track to meet your goals.
How much is $100 per month in a 529 worth after 18 years?
The future value of $100 per month in a 529 plan depends on the investment return and the number of years the contributions are made. For example, if you contribute $100 per month for 18 years and assume an average annual return of 6%, the total amount in the 529 plan would be approximately $41,000. This amount includes both your contributions and the earnings generated from the investments. Keep in mind that actual investment returns may vary, and past performance does not guarantee future results.
Is it possible to lose money in 529 plan?
Yes, it is possible to lose money in a 529 plan, as the investments within the plan are subject to market fluctuations. To minimize risk, consider diversifying your investments and choosing a more conservative portfolio as your child gets closer to college age.
what is the average rate of return on 529 plans
The average rate of return on a 529 plan varies depending on the specific investments chosen. Historically, returns have ranged from 3% to 8% per year. Keep in mind that past performance is not indicative of future results.
Why not use 529 for college?
Some families may choose not to use a 529 plan due to limited investment options, concerns about market risk, or the desire to use alternative savings vehicles. It’s important to weigh the pros and cons of a 529 plan before deciding if it’s the right fit for your family.
Do you lose 529 if no college?
If your child does not attend college, you have several options with your 529 plan. You can change the beneficiary to another family member, use the funds for eligible trade schools or apprenticeships, or withdraw the money and pay taxes and a 10% penalty on the earnings.
How much should I put in my 529 if my child is born?
The amount to contribute to a 529 plan depends on your financial situation and college savings goals. A good starting point is to estimate the future cost of college and work backward to determine a monthly or annual contribution amount. Keep in mind that you can adjust your contributions over time as your financial situation changes.
Is a 529 plan better than a savings account?
A 529 plan has the advantage of tax-free growth and withdrawals for qualified education expenses, whereas a savings account has lower returns and is subject to taxes. However, savings accounts are more conservative and provide easier access to funds. The better option depends on your risk tolerance and financial goals.
What age is too late to start a 529 plan?
It’s never too late to start a 529 plan, but the benefits may be more limited if you begin closer to the college years. You can still take advantage of tax-free growth, but your investment timeline will be shorter, which could impact your returns.
what is better than a 529 plan
There is no one-size-fits-all answer to this question, as the best college savings option depends on your individual circumstances and goals. Alternatives to consider include Coverdell ESAs, UTMA/UGMA accounts, Roth IRAs, Automatic Investment Plans (AIPs), and high-yield savings accounts. It’s essential to evaluate each option’s pros and cons before making a decision.