Saving for College: 529 Plans Debunked

Today's post is a continuation on our college savings series. If you've missed the earlier posts, here they are.

• Ten things to do before saving for college
• Retire First, College Later
• Reasons to Save and Not to Save for College
• 529 Plans Debunked
• Five ways to pay for college if you haven't saved

529 Plans Debunked

The options for college saving are nearly as broad as opinions on the topic. The federal government and most state governments have made it easier for us to save now than in the past. One of the best options for college savings is the 529 plan.

529 plans are a relatively new savings option. They were introduced in 1996 and are named after the section of the internal revenue code which created the plans. They basically come in two forms.

1. Savings plan where you put money into the plan and choose an investment. Growth of your savings is based on the performance of your investment choices. Investment choices are simple, so you don't have to know how a lot to choose.
2. Prepaid plans allow you to purchase tuition credits at current tuition rates. The performance of your investment matches annual tuition increases.

529 plans are administered by each state. Every state now has at least one 529 plan. The plans vary widely from state to state. The variations include investment options, expenses, and tax deductibility of contributions.

The benefits of a 529 plan include:

• High contribution limits. You can contribute $300,000 plus per beneficiary, depending on the state plan you choose. All states are at least $300,000.
• Contributions and earnings remain owned and controlled by the 529 account owner.
• Contributions are tax deductable on state income taxes in many states.
• Money not used by the beneficiary can be transferred to other beneficiaries. For example, you could transfer leftover money from an older child to a younger sibling. You could save your investment beyond your kids and transfer it to a grandchild if you'd like.
• Any growth of your investment comes out federal tax free if used for a qualifying college expense.
• Investments are simple. In most state plans you choose a year your child will start college and the fund manager makes the investment more conservative each year. Your investment will move from highly stock based when your child is young to mostly bond and cash based as she gets close to going to college. You don't have to think about it.
• Limited impact on financial aid eligibility. 529 plan assets owned by a parent are listed as parental assets. Therefore, they have a minimal impact on eligibility for financial aid.
• You can continue contributing to a 529 beyond a beneficiary's 18th birthday.
• Tuition rates in many states are climbing 7-10 percent per year, which is a great return. If you are confident your child will attend a state university, this makes the prepaid plan a good option.

Disadvantages of 529 Plans

• Any withdrawal for non-college expenses will be taxed as regular income and assessed a 10-percent penalty.
• Funds not use for college are stuck in the plan unless you choose to pay taxes and a penalty.
• Account owner can only make changes to investments once per year. I don't consider this a disadvantage, but some of you might.
• Fund expenses (amount charged by the 529 plan manager) are higher than normal mutual funds. If your child is within a couple years of college, this is a big reason to not go with a 529.
• Prepaid tuition plans lock you into state owned universities and colleges.

If you choose a 529 as a college savings vehicle, you aren't locked into your state's plan. If your state doesn't offer an income tax deduction, then you should look at other plans. Utah's plan does offer a deduction and has among the lowest expenses, so I've chose to save in our plan.