Is A 529 Plan Really The Best Way For You To Save For College?

The most popular college savings vehicle is the 529 plan. By the end of 2015, there were 12.5 million active 529 accounts in the US.(1) And they continue to grow in popularity. But is a 529 plan really the best way for you to save for your children’s college expenses? It might not be. This is why:

It Is Single-Purpose Money

Money that you put into a 529 plan can only be used for one thing — college. That puts a major restriction on a good chunk of your assets. What happens if you need the money for something else? What happens if you lose your job or have a medical emergency?

If money is withdrawn from a 529 plan for anything other than qualified higher education expenses, you will have to pay regular income taxes and a 10% penalty on all of the earnings. You already paid taxes on the original investment, so you won’t have to do that again.

Your Child May Get Scholarships

The most common question asked regarding 529 plans is, “What happens if my child gets a scholarship?” It’s a valid question since each year an estimated $4.6 billion is awarded in scholarships and grants by the US Department of Education and educational institutions and about $3.3 billion is awarded by private sources. In 2013, two-thirds of full-time college students used scholarships and grants to pay for their education.

If your child gets a scholarship and doesn’t need the money in their 529 plan, it can be withdrawn penalty-free. You will have to pay regular income tax on all of the earnings though. Even though the government does not charge a penalty, having the money needlessly tied up for years presents an opportunity cost in and of itself.

College Attendance Is Not Guaranteed

No matter how much you want your children to attend college, it’s not guaranteed. They may not attend college. Your child may end up the next YouTube sensation, major recording artist or join the military. Or something could happen that makes them unable to pursue higher education. What happens then?

In those cases, you can remove the funds from the account, but you will have to pay taxes and a 10% penalty on all of the growth, as mentioned above. You can also change the beneficiary on the account to another family member if that person is planning on attending college.

Limited Investment Options

Quite possibly the biggest drawback of 529 plans is their lack of investment options. Many plans only offer a handful of investment options, which may or may not be competitive. Do the tax savings that come with a 529 plan offset a subpar investment? Not necessarily. In many cases, investing outside of a 529 plan can bring greater returns or be more prepared to handle market volatility.

Seek Professional Advice

Saving for your child’s college education is important. But it’s also important to do a thorough analysis of all your options and not just follow the crowd into a 529 plan. There are a lot of good things about 529 plans, but they have their downsides as well. They greatly restrict family resources and limit investment options and returns.

Higher education is a valuable investment, so you should work with an experienced financial professional. Someone well versed in college savings plans and investments can help you review your options a decide which is the best for your family’s specific situation.

May 8, 2017

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