The pros and cons of having a 529 plan for your children’s college

Many are guided by the tax benefits of a 529 plan investment account to decide to save their money for education, however, it should not be your only reason.

A 529 plan is an investment account set up specifically for the purpose of having its funds used for qualified education expenses, especially college-related costs for your children or any beneficiary. So far, everything seems like an excellent option to avoid the overwhelming student debt that many families carry, including graduates. However, like any financial product, it has its pros and cons. While you have greater benefits for saving this money specifically for school, it is good that you know those not-so-pleasant details so that you know how to deal with them in the best possible way.

Pros of a 529 Plan

1. Growth and tax-free withdrawals

One of the main and biggest attractions of investment accounts in a 529 plan is the tax benefits they provide. The money you invest grows and can be withdrawn tax-free for qualified education expenses, which means every dollar you save goes beyond any other type of investment account.

For example, you have $1,000 to invest each year from the birth of your child and earn an annual return of 8%. 2% of that annual growth is in the form of dividends taxed at 15% per year and the rest of that growth comes from capital gains that are taxed at 15% when you sell.

At age 18, you would end up with approximately $36,999 after taxes in a regular taxable investment account. In a 529 plan, you would have $41,446 completely tax-free.

2. State income tax deductions

While you can’t deduct your 529 plan contributions for federal income tax purposes, there are 30 states that offer a state income tax deduction, and in some cases, you don’t even have to contribute to your home state’s plan. to get it.

3. High contribution limits

Unlike other investment accounts such as individual retirement accounts (IRAs), 529 plans have no income restrictions that prevent individuals from contributing and have few contribution limits.

A 529 plan’s lifetime contribution limits range from $235,000 to $500,000, depending on the state you open it in, though most don’t even have annual contribution limits, according to Saving for College.

For the most part, though, annual contributions from any one individual are effectively limited to $15,000 per year, per child, due to federal gift tax. A married couple filing jointly can combine that limit to reach $30,000 per year, per child.

4. Flexibility to change beneficiary

According to The Simple Dollar, every 529 plan has a designated beneficiary, which is the person for whom the money is saved. But you can change the beneficiary to almost any other family member, which means that if one child doesn’t need all the money for education, you can simply use it for another child, or even yourself, a grandchild, niece, or nephew.

Cons of a 529 Plan

1. Limited for education expenses

Despite its tax advantages, if you don’t use money from a 529 plan for qualified education expenses, earnings you withdraw for other non-verifiable educational purposes are subject to tax and a penalty of 10% of your withdrawal.

2. Some states penalize K-12 expenses

A K-12 expense refers to any payment you make for primary or secondary education. Federal law allows for tax-free withdrawals and zero penalties for qualified expenses of this type, however, there are states that can still apply their own penalties if money from a 529 plan is not used for higher education costs. It is best to approach an accountant or financial advisor specialized in these investment accounts to guide you in this regard, if you want to use the account for students with degrees below university.

3. Expensive investments

529 plans are still investment accounts managed by a financial institution. In this sense , the investment options you have in this regard can be expensive, depending on the state in which you are. For example, a Montana 529 plan offers several investment portfolios that cost about 0.80% per year, as opposed to a New York 529 plan where each investment option costs you 0.15% per year.

4. You forget other financial goals

Saving for your child’s education is great, but if contributing to a 529 plan is keeping you from saving for retirement, paying for health insurance, paying off debt, and getting other financial growth, then it’s not as good an idea as it sounds. The preparation of your offspring is necessary, but they can apply for scholarships for performance or certain talents that allow them to pay for their university studies in some way, something that you cannot do, for example, for your retirement or to pay what you owe.