529 Savings plans are the most popular college savings methods, and with good reason. There are so many good reasons to use 529 plans to save for your child’s education, like:
- Investments are tax-deferred, meaning your withdrawals will be tax-free
- 529 plans earn interest, similar to mutual funds
- Contribution limits are high
- You can invest automatically with monthly withdrawals
- The money in your account in transferable to different people
Another big benefit, as of 2018, is that you can now use up to $10,000 of your 529 plan savings to pay for K-12 education at a private, public or parochial school.
Despite all the upsides to investing in a 529 plan, there are some downsides and misconceptions to consider. Consider these points before you decide a 529 plan is right for your family.
Are 529 plans too limiting?
In terms of how much you can contribute, 529 plans are pretty flexible. Every state plan has its differences (and remember, you don’t have to choose your own state’s plan.)
Contributions to a 529 plan counts as a gift for tax purposes, which means that both you and your spouse could contribute up to $15,000 each in 2019 before you have to file Form 709 with your taxes. In that case, the amount would count against your lifetime estate and gift tax exemption.
So overall, there is a lot of flexibility in terms of how much you can add to a 529 savings plan.
What if my child decides to not go to college?
One holdup people run into is their fear that their child might not go to college, and all their careful savings would go to waste.
That’s not the case with a 529 plan. You have a couple options if you run into that situation.
529 plans are transferable. You could change the beneficiary to another member of your family, including yourself. If you don’t have a problem waiting, you could even save it for your future grandchildren. Most 529 plans don’t have a limit on how long you can keep them open, though you’ll want to verify that with your account first.
What if there is absolutely no one else who could use the money? You do have the option to take the money out of the account, though it’s not as simple as it sounds. Anything you have earned in that account is going to be taxable if it’s not used for education purposes. The amount you take out will be subject to your typical income tax rate, plus a 10-percent penalty.
So avoid pulling out the money entirely if possible, and see if there is a better option first.
Note: There are some exceptions to that penalty, including if the beneficiary:
- Dies or becomes disabled
- Receives a tax-free scholarship
- Receives educational assistance through a qualifying employer program
- Attends a U.S. military academy.
- Used qualified education expenses to get the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC)
What if I end up needing that money for retirement?
A good rule of thumb is to prioritize your retirement over your child’s education. It might sound harsh, but your children can borrow money to pay for school if need be. You can’t borrow money for retirement.
Make sure you are fully funding your retirement savings, and then budget for how much you can put in a child’s 529 account.
If you started saving a certain amount per year for your child, adjust it as you need depending on your situation. But don’t feel like you have to put away a specific amount. Even a small amount saved is helpful.
Do what you can, but make sure you’ve got your retirement covered first.
About Your Richest Life
At Your Richest Life, Katie Brewer, CFP®, believes everyone should have access to financial resources and coaching. For more information on the services offered, contact Katie today.