Should I Open a 529 Plan?

We often get questions from clients about whether they should set up a 529 plan for their child or grandchild for college.  With the rising cost of higher education, it’s more important than ever that families save early to fund college.  Direct funding from savings allows the student to avoid the long-term cost and burden of supporting higher education with student loans.  In addition, these plans have significant tax advantages when used for “qualified education expenses,” but there are other factors to consider. 

529 plans, named after Section 529 of the Internal Revenue Code, are tax-advantaged savings accounts designed specifically for educational expenses.  Funds saved in the 529 grow over time and can be withdrawn tax-free when used to pay for qualified education expenses, such as tuition, books, and room and board.  In 2019, changes to federal law broadened the use of 529 plans to include K-12 education and repayment of student loans, up to $10,000 each.  In addition, many states offer residents a state income tax deduction or credit for contributions to a 529 plan.  These plans generally have limited investment options that professional financial institutions manage, but those options allow choices of different objectives and investment styles.  The biggest potential tradeoff is that if the student does not use the funds for higher education or K-12, there may be penalties and taxes on the earnings to pull the funds out for any other purpose.   That said, the owner of a 529 may designate a new student beneficiary if the original student beneficiary does not use the entire balance.  Further, legislation passed in 2022 will allow up to $35,000 in unused 529 funds to be rolled to a Roth IRA for the beneficiary. 

Saving for college in a non-qualified savings account can add more flexibility in terms of usage of the funds but lacks the specific tax advantages of 529 plans.  In a non-qualified account, such as a regular savings or investment brokerage account, an investor can save and invest money without restrictions on how or when it’s used.  Funds can be used for educational expenses, but there are no tax benefits for doing so.  While non-qualified accounts offer greater investment flexibility, transactions in these accounts are subject to tax impacts due to capital gains, interest, and dividends.  These taxes can impact your overall return.

If you’re considering higher education savings for a loved one, the ultimate choice between a 529 plan and a non-qualified savings account depends on your financial goals and priorities.  If you want to maximize tax benefits and ensure that your savings are used for educational purposes, a 529 plan may be the better option.  However, a non-qualified savings account might be more suitable if you value flexibility and don’t want restrictions on using your savings.  It’s essential to weigh each option’s advantages and disadvantages and consider your circumstances when making this important decision.  Please let us know if you would like to have further discussion on this topic!