Benefits and Drawbacks of Investing in a 529 Plan

When it comes to preparing for your kids’ future education, the 529 Plan stands out as a powerful investment vehicle.

Given the notoriously high cost of education in the United States, this tax-advantaged savings plan offers a host of benefits that make it an attractive option for many parents, future parents, or anybody planning to pay for college.

Originally limited to postsecondary education costs, the 529 Plan was expanded to cover K–12 education (2017) and apprenticeship programs (2019).

With a bit of planning, you can use this plan to pay for education more strategically.

However, as with any financial strategy, it’s essential to understand both the advantages and drawbacks before deciding.

This article explores the benefits and potential downsides of investing in a 529 Plan, equipping you with the knowledge to make informed choices and secure a brighter future for your kids.

Benefits of Investing in a 529 Plan

1. Federal Income Tax Benefits (and Sometimes State Tax Benefits)
   One of the most significant advantages of a 529 Plan that sets it apart from regular savings accounts is its federal income tax benefits. Contributions made to the plan grow tax-free, and when funds are withdrawn* to cater to qualified education expenses, they are not subject to federal income tax. Furthermore, many states offer tax deductions or credits for contributions made to a 529 Plan, providing additional savings for residents.“Putting money into a 529 plan is a win on multiple levels,” said Daniel Lerner, Executive Vice President of Investment Services at David Lerner Associates, Inc.

   *In the case of K–12 students, tax-free withdrawals have a limit of $10k per year.
   

2. Low Opening Amounts
   Starting a 529 Plan requires relatively low initial contributions, making it accessible to families of all income levels.
   You can establish a 529 account with as little as $15-$25.
   This feature allows you to begin saving for your child’s education early on, giving your investments more time to grow.
3. High Contribution Limit
   529 Plans have generous contribution limits, allowing you to save substantial amounts for your child’s education. Starting in 2022, up to $16k per donor ($32k for married couples) per beneficiary is eligible for the annual gift tax exclusion.You can contribute as much as you wish each year as long as you don’t exceed the maximum contribution limit set by the state in which the savings plan is registered. States such as Idaho, Louisiana, Washington, and Michigan have maximum contribution limits of $500k+.

   These high limits make it possible to cover a significant portion of their college expenses.

   NB: There’s a new option to roll up to $35k of unspent funds into a Roth IRA account if the 529 savings plan account is 15+ years old.
   

4. Low Maintenance
   You can easily open a 529 plan account online or through a licensed financial advisor. Once you set up a 529 Plan, it requires minimal maintenance.This is because most 529 plans come with a list of pre-packaged investment alternatives to choose from.

   With automatic contribution options and professional portfolio management, you can rest assured that your 529 investments are being managed efficiently.
   

5. Flexibility to Access Out-Of-State Plans
   529 Plans offer amazing flexibility in terms of the choice of educational institution. You can invest in a 529 plan sponsored by any state, and you do not have to send your beneficiary to a college in the state that sponsors the plan.
   
   
6. Ability to Switch Beneficiaries
   If one beneficiary doesn’t use the funds, you can easily change the beneficiary to another family member, ensuring the savings won’t go to waste. You can change the beneficiary on your 529 plan as many times as you wish, provided the new recipient is a qualifying relative of the original beneficiary (siblings, spouses, first cousins, children, etc.).To make a 529 change of beneficiary, simply file the appropriate paperwork with your plan administrator.
7. Favorable Financial Aid Treatment
   Some assets and types of retirement accounts can make it awfully difficult for your kid to qualify for financial aid.529 Plans are considered parental assets in the financial aid calculation, meaning only 5.64 percent of the account’s value is counted against your child’s financial aid eligibility.This results in a more favorable impact on the student’s eligibility for financial aid compared to assets held in the student’s name.

Drawbacks of Investing in a 529 Plan

1. Penalty for Non-Qualified Withdrawals.
   Withdrawing funds from a 529 Plan for ineligible (non-qualified) expenses, with exceptions for certain circumstances, such as disability or death, may incur income tax on the earnings and an additional 10 percent penalty. Careful planning and understanding of the eligible expenses are essential to avoid penalties.
2. Limitations on State Tax Benefits.
   Not all states offer tax deductions or credits for 529 Plan contributions. Some states may also impose restrictions on eligibility, making it crucial to research the tax benefits specific to your state.To determine if this drawback applies to you, look up the guidelines surrounding 529 plans for your state.
3. No Self-Directed Investments
   Unlike some other investment options, 529 Plans do not allow for self-directed investments. You contribute money to the plan, and that money is invested in a pre-set collection of investment options. You have limited control over the investment choices, and the plan manager handles portfolio decisions.NB: As with most investments, investments in a 529 savings plan may not make you any money, and you could lose some or all of the money invested.
4. Relatively High Fees
   Some 529 Plans may come with higher fees than other investment options, which may lower your returns. The fees and expenses will vary based on the type of savings plan (education savings plan or prepaid tuition plan), whether it’s a direct or broker-sold plan, the plan itself, and the underlying investments.For instance, if you purchased your 529 plan through a broker, they may charge you as much as 5 percent or more on the assets under management (AUM).

   It’s essential to review and compare fees before selecting a specific plan.

Conclusion
A 529 Plan can be a great tool for securing your loved ones’ education and easing the financial burden of college expenses. Its tax advantages, low opening amounts, high contribution limits, and flexibility make it an appealing choice for many families.

However, it’s vital to be aware of the potential drawbacks, such as penalties for non-qualified withdrawals and limitations on state tax benefits.

By carefully evaluating the benefits and drawbacks and seeking guidance from DLA, you can craft a well-informed strategy that aligns with your financial goals and ensures a brighter future for your loved ones.

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Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable– we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.