529 Savings Plans Pros and Cons

The 529 Savings Plan is much like other tax-advantaged investments that are available to people trying grow their savings. The only difference is that instead of using these investments for qualified medical expenses or to plan for a retirement, the funds are used exclusively to pay for qualifying educational costs. This means households can save money, grow it tax-free, and then use it to pay for either their education or the education of their children.

Is the 529 Savings Plan right for you? Here are some of the key points to consider.

The Pros of the 529 Savings Plan

1. Each person in the family is entitled to have a 529 account.
Everyone, including the kids, is entitled to have their own 529 Savings Plan for their higher level educational costs. For a family of 6 in the United States, this means up to $24,000 could be saved and invested in a tax-advantaged way to offset the costs of tuition later on down the road.

2. Each state has different tax breaks on the income saved in these plans.
The income isn’t taxed for the 529 Savings Plan and each state approaches the tax breaks for making this type of investment in a certain way. For households in Rhode Island, the tax savings are rather minimal – about 2% of the total amount invested. For Indiana households, however, the tax savings could be as much as 20% of the total amount invested.

3. Capital gains taxes are not paid on the increase in plan value.
If you’re investing into mutual funds that grow as a means of saving for upcoming tuition costs, then that growth comes with a capital gains tax. Inside a 529 Savings Plan, that capital gains tax goes away. You still get the opportunity to invest into a number of different options as well, letting each individual stay in control of the investment.

4. It encourages better family budgeting.
When you’ve got $15,000 saved in the bank for higher level educational costs, it becomes a lot easier to spend that money on a new vehicle or a household repair because the money is there. “We’ll replace it when we get the chance,” many may think. That replacement doesn’t always happen. With the 529 Savings Plan, that money is earmarked for educational costs and places households into a position where they’re forced to budget.

The Cons of the 529 Savings Plan

1. The fees for earnings tend to be higher.
Compared to comparable mutual funds or other investments with a similar structure, the fees for the 529 Savings Plan tend to be somewhat higher. Although this is only a percentage point or two at most for a majority of plans, an extra 1% of a $4,000 maximum contribution is still $40 per year that won’t be going to tuition costs.

2. There are penalties and taxes involved for distributions that are not education-related.
In this respect, the money in the 529 Savings Plan is treated much like money that is contained within an IRA or 401k that is taken with an early withdrawal. The distribution is treated as income and taxed as such. There is also an additional 10% penalty that is placed on that income. For a $10,000 distribution, that suddenly becomes $9,000 after the penalty and then another $1,500-$2,500 could be taken away in taxes. States may also place an “administrative charge” on top of those costs.

3. The starting amounts are so low that they may not be beneficial.
Some 529 Savings Plans allow for a minimum contribution of $15 to begin saving for higher level educational expenses. Although other tax-advantaged plans may have higher starting points and mutual funds may require a minimum investment of $5,000 or more, the down side of this is that $15 doesn’t grow very fast from an investment standpoint. Something is better than nothing, but modest contributions won’t create much of a savings opportunity.

4. Distributions can’t be used if students are only taking a class or two.
If you’re working full-time and trying to go to school at night, then your schedule is already pretty full. With the 529 Savings Plan paying your way, it’s going to become even more packed. Students are required to be enrolled on a half-time basis at minimum to qualify for taking distributions.

The 529 Savings Plans pros and cons show that this can be an easy way for households to save for college expenses. It should be used only if going to college is something that is planned, however, because otherwise the taxes and fees could be extensive. Research 529 plans in your state today to see if these key points make an investment in your plan worthwhile.