Is a 529 Plan the Best Way to Invest for College?Submitted by Mission Financial Planning on May 18th, 2021
If you’re a parent or grandparent, it’s likely that you’ve thought about how to save for a child's education. Dentists' kids seem to have a higher propensity to attend graduate or professional school, so being financially prepared becomes a priority.
Paying for college is no small feat—with tuition constantly rising, college is a huge investment. One of the best ways to be prepared for the cost of college is to start saving early, and there are many ways to invest to reach that ultimate goal. Here are the pros and cons of investing in a 529 plan to help you make the right decision for you and your family.
Pro: Tax Advantages of 529s
One of the biggest advantages of investing in a 529 plan for your future college student is that the money will grow tax-deferred, and distributions will be tax-free as long as they’re used for college tuition or related expenses. These expenses may include room and board, books, supplies and other fees.
Many 529 plans also offer tax benefits on the state level. Depending on where you live, you may be eligible for a state income tax deduction or tax credit for contributions to a 529 plan. These plans are the only savings plans that offer tax benefits at the state level.
Con: Penalties for 529 Withdraws
As mentioned above, the 529 plan funds can only be used for qualified college expenses. If you take a distribution and do not use it for a qualified expense, you’ll owe income tax and a 10% penalty on that money. There are certain exceptions to this rule, including if a child gets a scholarship, attends a U.S. military academy, or becomes disabled.
You also may be on the hook for a penalty if you take a distribution too much in advance or too late. Withdrawals from your 529 should happen in the same year that they’re used for expenses.
With college costs so high it's hard to do, but be careful that you don't over-fund a 529 plan.
Pro: Easy 529 Investment Options
Many 529 plans offer target-date funds to make it easier to choose the appropriate investment. They use age-based portfolios that automatically become more conservative the closer your child is to college-age. The account will re-balance, and provides a hands-off experience. If the portfolio feels too conservative, you can adjust by choosing a longer time-horizon. Want something more conservative? Choosing a shorter time frame will accomplish that.
Pro: Flexibility in Plan Choice, K-12 Tuition, Who Uses the 529
You can invest in a 529 plan no matter what state you live in or where your student plans to go to college, which opens up a lot of possibilities. Many states offer a tax advantage no matter which plan you invest in, but check before assuming.
There’s no requirement as far as household income or regular contributions.
There’s also flexibility with beneficiaries. If your child decides not to go to college you can transfer funds to another child or even to yourself if you’re thinking of going back to school with no risk of distribution penalties.
Recently, the rules relaxed and 529s can be used for K-12 education, up to $10,000 per year.
Pro: 529 Contribution Limits and Gifting
Most plans have no annual contribution limit, but it's important to stay aware of gifting limits to avoid having to file a gift tax return.
Each parent (or grandparent) can gift up to $15,000 per child without worrying about gift taxes. However, when gifting to a 529, 5 years worth of gifts can be invested at once - that's 75,000 per parent or grandparent, per child.
529s have lifetime maximum contribution limits from $235,000 to over $500,000, varying by state.
Call us before making a significant contribution.
Paying for college is a big commitment - be prepared by starting to save early, choosing tax-advantaged investment tools, and invest with your college funding goals in mind.
If you have questions about the specifics of investing in a 529 savings plan for your child’s future, reach out by scheduling a time to talk.