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Saving for College—the 529?

Jessica Lanning

People are often surprised that I don’t recommend using 529 plans as a college savings plan.  Section 529 of the Internal Revenue Code allows you to take after-tax dollars, put it in a “529 account” in any state’s plan you want, and not pay tax on the growth in the account so long as you use the money to pay for higher education costs.  Seems like a good deal, right?  Not so fast.

Reasons not to use a 529 plan

  1. If you’re underfunded for retirement, you can’t afford it.  You can borrow to send your kids to college.  You cannot borrow for retirement.
  2. Not all state plans are created equal.  You have to do your research and you have to keep an eye on fees and investment choices.  States can change their plans.
  3. You’re opening another (many?) accounts.  That typically means more fees.
  4. If your kid doesn’t go to college, you have to change the beneficiary of the account and that person must be related to the kid.
  5. Most investment options are subject to market fluctuations and if your kids are close to college age, you probably can’t risk that much volatility.
  6. Any 529 plans in your name count on the Free Application for Federal Student Aid, or “FAFSA” form, which is the standard form at most schools for applying for student loans.  This may limit your ability to borrow since the school will see that you can afford to pay.
  7. That same FAFSA form is also used by schools to determine who will get scholarship or endowment money that never needs to be paid back.  Imagine your kid going to college and someone else paying for it.  The fewer assets you have to disclose on the FAFSA, perhaps the better.
  8. Life happens.  What if you need that money for other things?  Taxes and a penalty for withdraw for non-educational purposes.

Who should fund a 529 plan?

This is a no-brainer strategy for folks who are well-funded for retirement, committed to paying for their kids’ college education (no loans, no scholarships), and are certain that their kid or grandkids will go to college.  Oddly enough, the wealthier clients that I meet who can afford to do this have been advised against it by other planners.

Other options?

If you want a 529 plan, consider having your parents open it up.  You can contribute, but you don’t control it.  If you’re an employee, consider creating a retirement plan for yourself that allows you to access the assets tax-free for college educations. If you’re a business owner, consider doing the same and/or creating a welfare benefits plan for your business.  In both of these instances, the money you are saving could be—but is not required to be—used for college expense. If the money is not used for college, it can serve other purposes in your life.