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Saving for College: Pros & Cons of 529 Plans

I get this question a lot: How do we save for college?  Well, it’s a complicated question that I hope to help answer in a series of blog posts and articles starting with my last post “what is a 529 plan?“.  Today, I’m going to talk about the Pros and Cons of 529 plans. Unfortunately, there is no perfect way to save for college right now because returns on mutual funds or other investments (whether managed by you or someone else) are not outstripping college tuition increases (about 7 %/year). The point is to start saving even when returns are low and even when there is no perfect plan or vehicle.  I can’t say a 529 is right for everyone, but it is very right for some people.  If a 529 plan doesn’t suit you, you might need a combination of options like a Roth IRA, Coverdell ESA, Savings account, or UTMA. I will go through all of these next time around. So here’s the deal as I see it:

A 529 plan is GOOD FOR YOU if you are the following type of person (financial DNA):
1.       You like systems to make you save direct deposits or automatic contributions each month or year
2.       You like compartmentalizing your financial life: x for college, y for retirement, z is for emergencies,
3.       You don’t want to do the actual investing. You’re happy to let someone else invest for you even if you could get another 1-2% if you invested with someone else or managed the investments yourself
4.       You like structure and do your homework at the outset (so does your child so he/she is probably going to college). You figure out which plan is best for you early and don’t want to worry about it again.

A 529 plan is BAD for you if you are the following type of person (financial DNA):
1.       You can’t cede control to anyone and need to be in there picking stocks and watching the market
2.       You’re all about return. You don’t mind paying a little tax as long as you’ve optimized your return.
3.       Your child has many talents. He may end up a pro snowboarder, never going to college.
4.       Fees make your skin crawl especially since you can do it better.

Everybody likes tables, right? If you see a * that means CHECK YOUR SPECIFIC PLAN FOR DETAILS. Also, I’m talking about 529 Savings plans here not pre-paid plans (more on that later).

Next week, I will talk about the difference between “savings” 529s and “pre-paid” plans, and after that, I will talk about UGMA/UTMAs, Coverdell ESAs, Roth IRAs and other ways to save. After all that, I will do a comparison and give some guidance on which one or combination might be right for your family.

529 PROS529 CONS
You are deliberately saving for college!!! Yay you!!!529 plan fees can be BIG
Bankruptcy protection for deposits older than 2 yrsIt’s hard to make a sizable return after fees in the current investment climate (1-3%)
No Federal tax on growth/earnings on depositsYou have no say in how your funds are invested once you choose a plan and an investment option
No limit on deposit amounts or times to deposit – but over $13,000 in 1 yr and you may trigger Generation Skipping Transfer (consult your tax preparer)Some plans can be overly exposed to stocks (higher risk) when your child is close to needing the money (need lower risk)
No age limit for beneficiary in most states*Plans can lose money in a downturn wiping out a lot of your college savings
Some states* offer a tax break on state tax for the account’s growth/earningsYou pay 10% penalty if you need to use the funds for something else or your beneficiary does not go to college
Discipline: You can’t take the money out without penalties and spend it on a boatYou can only change beneficiaries once per year*
Other people can contribute to the plan – that means you grandpa and grandma!529 funds can’t be used for anything besides post-secondary schooling. Good luck with private school (k-12)
You can change beneficiaries if one child decides not to go to college
Funds can be used at any accredited post-secondary institution*
Though there are restrictions on use, 529 funds can be used for books/room/board/tuition (all the basics)
Professionally managed funds, so you don’t have to worry about making investment decisions
For people who like compartments or checking boxes, you can only use 529 funds for college so that box is checked
No limit on contributions based on Adjusted Gross Income
Can be used internationally as long as post-secondary institution meets IRS criteria (check IRS.gov)
Direct Plans can save you money on fees compared to broker sold plans