Increasingly, I am seeing opinion and data-based pieces questioning the value of a college education. Exploding student debt rates and outrageous price tags make for flashy headlines and strong opinions, but the pros and cons list is, for lack of a better word, complicated.
Now, in the interest of full disclosure, I come down on the pro-college side. My parents are college-educated, and it was always a matter of assumption that my siblings and I would be as well. However, I can see that the decision to attend college mirrors many financial decisions in that it is specific to the person and the institution under consideration, and possible permutations of those variables number in the millions.
Which leaves us with a dilemma – to save or not to save. Happily, there is a savings vehicle that is nearly tailor-made for the times: the 529 plan.
First, 529 Plans are named for section 529 of the Internal Revenue Code, which, as you might have concluded, is responsible for their existence. The intricacies of 529 plans are details for another post, so for purposes of my point today I will broadly differentiate between savings and prepaid plans.
With a 529 savings plan, you choose where to invest your contributions from the plan’s available options, and the proceeds can be used for college expenses at any eligible institution. On the other hand, think of a prepaid plan as buying future tuition at a specific institution or group of institutions in today’s dollars.
The crucial elements
Two features combine to make 529 plans unique as college savings vehicles: large account limits and flexibility. 529 plans have no age, income or contribution limits, beyond the overall limit on account size. This limit varies by state, but several are over $300,000, a unique feature among college savings vehicles. Also, it is the donor, not the beneficiary, who retains control of the assets in a 529 plan. (There are a few exceptions to that, but they are unlikely to apply in this context.)
529 plan contributions are made with after-tax dollars, but earnings grow free of federal tax. Some states also offer tax benefits, from deductible contributions to no state tax on earnings. (You can invest in a plan from any state, no matter where you live or where you expect your beneficiary to attend college, but this state tax feature makes it prudent to check out your own state’s plan first.)
But what if you put all that money away and your beneficiary doesn’t attend college? 529 plans offer several options, none of which carry drastic consequences.
- Change the beneficiary. Say you have three children (or grandchildren), and you open 529 plans for each of them. (Actually, if their ages suggest they won’t be in college at the same time, you could do with just one.) In the event one of them decides not to attend college, you can simply change the beneficiary to a sibling (or cousin, if you’re a grandparent) and use the funds for that child’s expenses. (Actually, you could choose to fund a neighbor’s education if you wanted – there are no restrictions requiring a familial relationship. I was merely going with the most probable.)
- Change the account owner. If all of your children have grown and you still have funds in a 529 plan, you have the option to designate your child as successor account owner, which means that the plan that was intended to fund your child’s education can now fund a grandchild’s. If grandchildren aren’t in the picture yet, don’t worry – your child can be listed as both account owner and beneficiary until the next generation makes an appearance.
- Make an unqualified withdrawal. This is the sole option with monetary consequences. (I didn’t say there wouldn’t be consequences; I said there aren’t drastic consequences.) Penalties for nonqualified withdrawals are income tax and a 10% penalty on earnings. Obviously, the issue is the 10% penalty on the earnings (the 10% does not apply to principal), and I’m the first person to agree that it’s not ideal. However, as worst-case scenarios go, 10% on earnings isn’t much of a downside risk, as it is somewhat offset by the benefits of tax-deferral. Additionally, the 10% penalty does not apply if the amount withdrawn is equal to a scholarship received by the beneficiary.
Obviously, there are many other factors to consider in choosing to invest in a 529 plan or to save for college at all. Determining whether you are in a position to save for college is number one, and a careful evaluation of the available options is a must. But tying your money up, in my opinion, is not a significant risk of 529 plans.
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