I am a father of 2 kids – 4 & 6 years and planning to start a 529 plan for them for college. Is a 529 plan the best way to save some money for college?
Last week when I was on Minnesota Public Radio, a listener submitted the question above. I am going back today to give a more detailed response to his question.
What is a 529 plan?
A 529 plan is “an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs.” 1 It got the name from Section 529 of the Internal Revenue Code which created these types of plans.
Starting a 529 plan
You can be a father like Sammy or a mother, aunt, uncle, grandparent, or just concerned friend of the family. There are few restrictions on who can start a 529 plan. In fact if you are returning to college, you can even start a 529 plan for your own future college plans.
Why is a 529 plan the best way to save for college?
A 529 plan has three main advantages. The first advantage is that money in a 529 plan grows tax deferred and if it is used for college, then the money in the account can be withdrawn tax-free. During the time the money is in a 529 plan, you will not receive a 1099 for any gains or losses incurred during the year, nor will you pay any taxes while the account is growing.
A second advantage of a 529 plan is that families can make a significant investment into the plan in 1 year. For 2013, a married couple can put up to $140,000 into a 529 plan for each of their children or grandchildren in one year. That amount is significantly more than that same couple could put into other types of plans that could be used to save for college.
The third advantage of a 529 plan is the person who opens the plan retains control over the assets. What that mean is if circumstances change after the account is opened and you need to use the funds in a 529 plan for yourself, you can. You may have to pay a 10% penalty, but the funds are yours.
A 529 plan may not be the best choice for you
While there are many advantages to the 529 plan, it may not be the best choice for everyone. The main complaint I hear about 529 are the fees. In addition to the fees a mutual fund may impose for administering a 529 plan, the state that offers the 529 will also impose a fee. The fees can be a drag on performance.
While the fees can be a drag on the performance, the performance is enhanced by the fact the balance grows tax-deferred. As long as the tax deferred growth is more than the cost of the fees imposed, a 529 plan can still be a good investment for your family.
A family considering a 529 needs to weigh the benefits of tax-deferred growth, significant contributions limits and maintaining control of the assets for unexpected changes in their finances. This contrasts with the fees embedded in a 529 plan which should be less than the gains made by the plan over time. Once your weighed the pluses against the minuses, you can make a decision about whether a 529 plan is the best plan for you.