The tax advantages of 529 college savings plans have made them a popular way to save for a child’s higher education. However, there are a several things to think about before you make a 529 part of your approach to saving for college.
Consider investment risk. With a 529 college savings plan, your contributions are generally invested in mutual funds with varying degrees of risk. 2008 served as a reminder that the long-term performance of these investments can be hampered by short-term volatility. In short, you can lose money. If you aren’t fully comfortable with the risks of investing, consider more conservative portfolios or options like CDs or stable value funds. However, it’s important to understand that choosing lower risk options often means lower return potential on your savings.
What if I don’t use the money for college? If you withdraw funds from a 529 college savings plan and use them for non-qualified costs, a 10% federal penalty applies and the proceeds and account earnings will be taxed as income. However, 529 plans do offer you some flexibility. If your child decides not to attend college or you think there’s a good chance that your child will not attend college, you don’t have to withdraw the money. Instead, you can change the beneficiary to another family member.
529s can be used to pay for most, but not all schools. 529 college savings plans can be used to pay for qualified higher education expenses at most accredited colleges and universities in the U.S. However, many junior colleges, technical colleges and vocational schools are not accredited. Check with the school to determine if it is accredited.
Understand the impact on financial aid. One benefit to 529 college savings plans is that the assets are treated as assets of the account owner (generally the parent) when determining eligibility for financial aid. Other rules may apply if the 529 is part of a Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) account, or if the account owner is a grandparent. Contact a college’s financial aid office or tax advisor to get the full details behind rules and requirements.
Fees can vary widely. 529 college savings plans fees can differ dramatically and impact your account’s value over time. It’s important to do your research and ask detailed questions about all of the fees involved in a given plan.
Understand your investment options. Some 529 college savings plans offer more flexible investment options than others. Be sure you carefully review the risks associated with an investment.
Read the fine print on transfers from non-529 plan accounts. While you can generally transfer another investment account, such as an UGMA or Coverdell account, into a 529 college savings plan, it may trigger a taxable event. In addition, the account ownership rules will differ. Therefore, you should consult with a financial or tax advisor before performing a transfer.
529 assets can actually affect Medicaid eligibility. If you’re an older plan owner who may soon need Medicaid coverage, it’s important to know that assets in a 529 college savings plan can reduce the amount of Medicaid you’re eligible to receive. Also, older givers should be aware that financial gifts they give to a 529 college savings plan, while exempt from gift and estate taxes, may still affect their Medicaid eligibility. Given this, it’s important to consult with a financial advisor to determine how a financial gift may impact your eligibility.
If you’ve gotten this far, you’re probably seriously considering investing in a 529 plan. If so, make sure you fully understand the tax advantages of 529 plans offered within and outside your state. But don’t stop there. As with many situations in life, the more you investigate the better opportunity you’ll have to make the best decision for your personal situation. Take the time to read up on the nuances of 529 college savings plans and other ways to save for college. Given the importance of saving for college, we also recommend that you seek the expertise of a professional, like a financial advisor. Not only can he or she explain your options, an advisor can also determine how your college savings approach fits into your overall financial goals.
Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose value. Please note the plan's disclosure document includes details such as investment objectives, risks, charges and expenses, and other information that you should read and consider carefully before investing. You can obtain a copy of the plan document from each 529 plan sponsor.