529 plans have become one of the most common ways parents save for their children’s college expenses. Why do families choose a 529 over just an old savings account? There are two main advantages, plus one limitation worth knowing about.
Pro #1: The tax advantages
The first reason has to do with taxes. Many states have a state-sponsored 529 plan, and in some cases, putting money into a 529 allows you to get a state tax deduction on the dollars you contribute (subject to limits).
529 plans are also tax-efficient on the back end. You can invest the money, and as it grows and you ultimately use it for college, none of the money that comes out of the account is taxable. That’s true for both your contributions and your earnings, as long as the funds are used for college expenses.
Pro #2: Flexibility in how you use the money
The second big advantage is flexibility. You can use the funds at essentially any college in the United States, and if you save money for one child who ends up not going to college, you can remove their name as the beneficiary and put another child or close family member on the account instead. There’s a lot of built-in flexibility with 529 plans.
Con: The funds have to be used for college
529 plans aren’t every family’s sole college savings vehicle because the funds are restricted to college use. If the child ends up not going to college, or the money is needed for another purpose, you’ll pay tax on any earnings in the account plus a 10% penalty.
It helps to get ahead of this by thinking through what you expect college expenses to look like when your child reaches college age, how many children you have, and who else could use the account. 529 plans are an important option to consider when you’re saving for college. As always, coordinate with your accountant and your advisor to make sure it’s a good fit for your family.
