Children Education Savings Plan: Pros and Cons of Using a 529

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If you’re starting to think about your children education savings plan, you may want to consider opening a 529 college savings account. After all, college costs continue to go up, and so do the student loan debts (as many of us are still painfully aware). If you want to lessen that burden for your children, it’s a good idea to start saving for their future as early as possible. Below is a detailed guide covering the pros and cons of opening up a 529 savings plan for your child as well as the most frequently asked questions.

I started my children’s 529 plans right after they were born. Any monetary gifts I get for my children go directly into their respective 529 accounts. I even send out a link to family and friends that allow them to contribute directly to my children’s individual 529s for their birthdays (Fidelity has this option).

I also add to my children’s 529 plans periodically throughout the year. Because my husband and I have been dedicated to growing their accounts, my 6-year-old has enough money saved to pay for her first year of college!

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What is a 529 Plan?

A 529 plan is a savings account with tax benefits that is designed specifically for future education costs. 529 plans are state-sponsored and almost every state sponsors at least one 529 plan.

There are two types of 529 plans: an education/college savings plan and a pre-paid tuition plan. A pre-paid tuition plan allows you to pre-pay all or part of the cost of participating colleges and universities (usually public and in-state). A pre-paid tuition plan usually can’t be used for future room and board, or to prepay tuition for elementary or high school.

An education savings plan, which is more common, allows you to open up an investment account to save for future education expenses. It offers more flexibility because you can use it to pay for almost any accredited college nationwide and for a wide-range of expenses, including room and board. It can be also be used to pay for K-12 education.

Since pre-paid plans are less common and offered by few states, this post will focus on the 529 education savings plan.

When Should You Start a 529 Savings Plan?

Ideally, as soon as your child is born. The earlier you save, the longer the account will earn interest and grow!

While you can open up a 529 before your child is born, the child can’t be a beneficiary until they have a Social Security Number. However, you can open the account with yourself as the beneficiary, and then change the beneficiary to your child after they’re born.

Benefits of a 529 Savings Plan

There are several benefits of a 529 College Savings Plan:

1. Flexibility

You can typically use the money saved in a 529 savings plan for a variety of education-related reasons:

• Public, private, or religious K-12 (elementary, middle, and high school) tuition and fees- up to $10,000 per year per beneficiary
• Public or private accredited college, university, and graduate school tuition and fees
• Vocational and trade school, as long as it participates in the federal student aid program administered by the U.S. Department of Education
• Room and Board (if you’re enrolled at least half-time), including off-campus housing as long it is doesn’t exceed the cost of university-owned housing
• Textbooks required for courses
• Student loan debt (with a lifetime limit of $10,000 penalty-free per beneficiary)
• Food and meal plans, including food purchased if you live off-campus as long as it’s not more than what your college charges for meal plans
• Computers, printers, and internet service used primarily by the beneficiary while enrolled in college, as well as software if it’s required for school (like Microsoft Word).

2. Tax-free withdrawals

You won’t pay federal income taxes (and in some cases, state income taxes) on the earnings of a 529 plan as long as you use it for qualified education expenses.

It’s important to learn all the rules of qualifying expenses and withdrawals and keep records and receipts for when it’s time to report 529 withdrawals during tax time.

3. State Tax Breaks

Many states also offer full or partial tax deductions or credits to residents for contributions made to their own state’s 529 plan.

4. Investment options and returns

529 savings plans offer investment options and returns. For example, you can choose an investment portfolio that is age-based where the asset allocation becomes more conservative as the beneficiary nears college age. You can also choose a target investment portfolio that will adjust allocations on your desired level of risk (conservative, moderate, or aggressive).

You’re generally allowed to change your investments twice a year or whenever you change beneficiaries.

Investing the money in stocks and bonds vs. keeping it under the mattress or putting it in a low-interest savings account also means that your 529 plan can offer greater returns over time.

5. No Income, Age, or Annual Contribution Limits

Unlike others savings plans, like a Roth IRA, there are no income or annual contribution limits. So it doesn’t matter how much you earn, you can still contribute to a 529. You can even use it to fund your own continuing education as there are no age limits!

6. Beneficiary Can Be Changed

You can change the beneficiary to a qualifying family member of the current beneficiary at any time without tax consequences.

So let’s say that your oldest gets a full-ride scholarship and no longer needs all of the 529 money or decides not to go to college at all, you can change the beneficiary to one of her siblings. Other qualified family members include the beneficiary’s spouse, children, parents, step-family, aunts, uncles, cousins, and even in-laws!

Drawbacks of a 529 Savings Plan

1. You Can Lose Money

Although a 529 Savings Plan can provide great returns, there is always the possibility that you lose money invested in a 529 plan if the investments go down in value. A lot of it depends on the type of investment portfolio you select. That’s why it’s important to pick a portfolio and strategy that will reflect your level of risk and the amount of time left until your child is college-age.

For example, I started investing for my child right after they were born. I chose a 529 Plan administered by Fidelity that offers Aggressive Growth and is heavily invested in stocks. Why? Investing in the market typically yields higher returns and because time is on my side. Even when the market is down, I have over a decade for it to bounce back. That being said, as my child starts nearing 18 years old, I want to protect that money and start reallocating it into safer investments.

If you want to have a hands-off approach to your 529, age-based portfolios are a great option as they will automatically do the reallocation for you as your child gets older.

2. Taxes and Penalties for Ineligible Expenses

If you take out withdrawals for ineligible expenses (such as personal, non-education-related expenses), the IRS will consider those withdrawals as income, tax you on it, AND charge you a 10% penalty on the earnings of the 529 plan. That’s why it’s important you understand what you can spend 529 withdrawals on and keep relevant receipts and records.

3. Limited Investment Options

Each 529 plan is different and depending on the plan, you may have limited investment options. For example, some plans only offer a limited amount of age-based portfolios with little asset diversification. For those who are experienced active investors who prefer more control over their investments, this may be a huge con. For those who are less experienced or prefer a set-it-and-forget it strategy, this might actually be a benefit.

4. Can Have High Fees

Your 529 can have fees just like any other investment account. The fees include enrollment/application fees, account maintenance fees, management fees, and expenses of the underlying investments (expense ratio). If you buy a 529 plan from an advisor, you may also be paying a sales charge. The more fees you’re paying, the less money you’re investing. Before selecting a 529 savings plan, make sure to shop around and compare the total expenses of each plan, and choose a low-cost option that won’t eat significantly into your returns.

Where to Open a 529 Savings Plan

You can open a 529 Education Savings Plan directly through a state’s plan or through a broker/advisor. The advantages of opening a 529 through a direct-sold plan is that it will carry lower fees than a broker or advisor. However, some people may prefer advisor-sold 529s for the professional guidance and greater investment options. Whatever you decide, do your research, compare plans, and pick a low-cost plan that works best for your needs.

Last Word on 529 Children Education Savings Plan

The pros of saving in a 529 plan, including the tax-free growth and withdrawals, far outweigh the cons. What’s important is that you start saving early and regularly – the longer you save, the more money will accumulate by the time your child is ready for college. In the end, the goal is to save enough money for your child so that they have a head-start to pursue their career and be successful!

Frequently Asked Questions About 529 Plans

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Hi I’m Yesenia,

a working mom of two kids. I’ve experienced all of the beautiful and crazy moments of early parenthood: breastfeeding, picky eaters, toilet training, balancing work with kids, and the list continues!

I created Hard Knock Mama to help working moms navigate through their child’s early years and find a successful balance in their home, work, and life.

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