If you’re a parent of a child who may be heading to college in the future, it’s likely that you’ve thought about how to pay for their tuition. But paying for college is no small feat—with tuition rates 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. While there are many options available for savings plans, one you may consider is a tax-advantaged 529 plan. 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
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, but it’s a good idea to check with your financial professional before taking distributions to make sure your expenses qualify.
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 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 your child gets a scholarship, attends a U.S. military academy, dies or becomes disabled.
You also may be on the hook for a penalty if you take a distribution before you're ready to use it. Withdrawals from your 529 savings plan should happen in the same year that they’re used for expenses. For instance, if you withdraw $10,000 and only use $8,000 to pay for tuition one semester with plans for using the rest to pay for the next semester, you may be subject to a penalty fee.
Con: Limited Investment Options
While there are tax benefits for 529 plans, if you’re someone who prefers to have a lot of control over your investments you may want to consider saving elsewhere. Many 529 plans have limited investment options, including static investment portfolios to mitigate risk and age-based portfolios that enable you to be more conservative the closer your child is to college-age. If you’re a savvy investor, it may be a smart decision to control investments on your own. But if you’re okay with a hands-off approach to investing for your child’s future, this may not be a con for you.
Pro: Flexibility in Other Areas
While there may not be a breadth of investment options, 529 plans do have a lot of flexibility in other ways. You can invest in any 529 plan no matter what state you live in or where your student plans to go to college, which gives you many options to choose from. 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.
Another benefit of 529 plans is their high contribution limits. Most plans have no annual limit and aggregate contribution limits from $235,000 to over $500,000, varying by state.
If you have questions about the specifics of investing in a 529 savings plan for your child’s future, reach out to a financial professional for help.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2023 Advisor Websites.