A 529 plan is a special account that helps you start saving well in advance for your child’s college expenses. You act as custodian of the account while your child is the beneficiary.
529 plans have pros and cons, but experts still recommend them for most families.
For example, let’s say you want to start a 529 plan now to begin saving for your newborn’s future college expenses. According to data from the National Center for Education Statistics, we’ll assume current all-in annual college costs of $28,000. Using this Bankrate® calculator, to help adjust for inflation, you’ll find that contributing $508 a month to a 529 plan will get you where you want to be – assuming a yearly 4.8% inflation in college costs and a reasonable 7% annual return.
When it’s all said and done, you will have made about $134,000 in contributions, but you will have also earned nearly $155,000 in interest.
If those numbers sound appealing, keep reading. We’ll cover the advantages and disadvantages of 529 plans and see 529 comparisons across different states.
529 Plan Advantages
You fund a 529 plan with after-tax dollars (unlike, say, pre-tax 401(k) contributions), so your earnings won’t be subject to federal income tax when you withdraw them later – much like a Roth IRA. Many states also offer tax deductions or credits too, though these vary by plan.
Almost anyone can contribute to a 529 plan, meaning other family members could contribute to your child’s education fund. The only limit on annual contributions is that they can’t exceed what will be necessary to cover the qualified education expenses of the beneficiary. Also know that if you contribute more than $14,000 a year, you may need to pay a gift tax.
You can switch 529 plans up to once a year by rolling over the balance without paying any sort of penalty, and you can also change the plan beneficiary if necessary.
Minimal impact on financial aid
When parents contribute to a 529 on their child’s behalf, the account is classified as a parental asset for financial aid purposes, just like most other kinds of savings. That won’t have as much of a negative impact on other financial aid as parental income or the student’s own assets.
529 Plan Disadvantages
Much like some IRAs, you’ll owe income tax and a steep 10% early-withdrawal penalty on earnings if you try to tap your 529 savings early. If you aren’t a disciplined saver, this could be a pro. 529 plans should never function as a general savings account and you should dip in early only as a last resort.
Limited investment choices
While many parents feel simplicity is an advantage of a 529 plan, perhaps you’re a more seasoned investor who likes to pick and choose individual stocks. In that case, you might find your portfolio choices limiting, or in the case of prepaid 529 plans, nonexistent. The number of times you can change investment options and allocations may also be very low.
One alternative open to more sophisticated investors is to use a Roth IRA, which offers many more investment choices, including individual stocks or even options. Roth IRA contributions and earnings can be withdrawn tax and penalty-free after five years if used for qualified educational purposes. However, Roth IRAs carry stricter income and contribution limits, and this approach takes discipline — you shouldn’t be raiding your retirement savings to pay for college.
No guarantee of returns
Unless you choose a prepaid 529 plan (more on these later), you are taking on risk just like any other investor. While some plans allow you to dial down the risk as your child gets closer to college age, there are still no guarantees.
Where Should I Open a 529 Plan?
Most states offer their own 529 plans with tax breaks meant to keep your money in your own state. However, that doesn’t preclude you from using another state’s plan, especially if there is little or no tax incentive offered in your own state.
Aside from tax benefits, another thing you’ll want to keep an eye on is fees. Many of the best plans, particularly state-sponsored ones, keep 529 fees reasonable. However, fees of up to almost 3% of your plan’s assets aren’t unheard of. Paying 529 fees that high may mean any tax benefits are cancelled out.
Here’s a list of which states offer tax benefits for residents who invest in their 529 plans, culled from investment research firm Morningstar:
|Tax benefits for
|Alabama||up to $5,000/$10,000||No|
|Arizona||up to $2,000/$4,000||Yes|
|Arkansas||up to $5,000/$10,000||No|
|Colorado||full contribution amount||No|
|Connecticut||up to $5,000/$10,000||No|
|Georgia||up to $2,000/$4,000||No|
|Idaho||up to $6,000/$12,000||No|
|Illinois||up to $10,000/$20,000||No|
|Iowa||up to $3,098/$6,196||No|
|Kansas||up to $3,000/$6,000||Yes|
|Louisiana||up to $2,400/$4,800||No|
|Maryland||up to $2,500/$2,500||No|
|Massachusetts||up to $1,000/$2,000||No|
|Maryland||up to $2,500/$5,000||No|
|Michigan||up to $5,000/$10,000||No|
|Minnesota||up to $1,500/$3,000||Yes|
|Mississippi||up to $10,000/$20,000||No|
|Missouri||up to $8,000/$16,000||Yes|
|Montana||up to $3,000/$6,000||Yes|
|Nebraska||up to $10,000/$10,000||No|
|New Mexico||full contribution amount||No|
|New York||up to $5,000/$10,000||No|
|North Dakota||up to $5,000/$10,000||No|
|Ohio||up to $4,000/$4,000||No|
|Oklahoma||up to $10,000/$20,000||No|
|Oregon||up to $2,375/$4,750||No|
|Pennsylvania||up to $15,000/$30,000||Yes|
|Rhode Island||up to $500/$1,000||No|
|South Carolina||full contribution amount||No|
|Utah||up to $2,000/$4,000||No|
|Vermont||up to $2,500/$5,000||No|
|Virginia||up to $4,000/$4,000||No|
|Washington, D.C.||up to $4,000/$8,000||No|
|West Virginia||full contribution amount||No|
|Wisconsin||up to $3,050/$6,100||No|
The following states offer 529 plans with no tax breaks (some because there is no state income tax): Alaska, California, Delaware, Florida, Hawaii, Kentucky, Maine, Nevada, New Hampshire, New Jersey, North Carolina, South Dakota, Tennessee, and Texas. Washington state and Wyoming.
What if my state’s 529 plan doesn’t offer tax breaks?
Remember, you can shop around regardless of your state’s 529 benefits, or lack thereof. Some states, reflected in the table above, even offer tax benefits regardless of whether you choose an in-state plan or go with another state’s.
If you decide not to go with your own state’s plan and need a bit of help choosing the best 529 for you, you’ll find five of the best 529 plans in the nation below. All earn high marks from sources including Kiplinger, Morningstar, and Savingforcollege.com. None of these plans have residency requirements for plan custodians or beneficiaries, so you can live anywhere and still take advantage:
Maryland Senator Edward J. Kasemeyer College Investment Plan
The Maryland College Investment Plan is one of Morningstar’s nine silver-rated plans. Administered by T. Rowe Price, this plan has a range of quality funds, according to Kiplinger. It ranks eight on SavingforCollege.com’s 10-year investment performance list. It’s also a particularly good pick for those who want to be a little more aggressive with a heavier investment in stocks. You’ll have your choice of nine different portfolios.
Nevada Vanguard 529 College Savings Plan
This Nevada plan is one of Morningstar’s four gold-rated options. It earns particular raves for keeping costs low and utilizing a broad range of strong Vanguard index funds. You’ll have three age-based and 20 static plan options.
New York 529 College Savings Program: Direct Plan
New York’s 529 plan offers an appealing blend of low fees and age-based portfolios that let you make aggressive, moderate, or conservative investments based on your child’s age, according to Kiplinger. It’s also the sixth-best plan on SavingforCollege.com’s 10-year investment performance list. You’ll have three age-based and 13 static plan options.
Utah Educational Savings Plan
A strong all-around performer, the Virginia CollegeAmerica plan gets high marks from SavingforCollege.com as a particularly good pick for low fees and strong investment performance. This plan is also the biggest in the U.S. with $65 billion in assets. You’ll have a wide array of plan options and a dedicated financial adviser to help you make the right decision.
Should I buy a 529 plan direct from a state or through a financial advisor?
Just as you can buy a 529 directly through a state, financial advisors also offer these plans, such as the Virginia CollegeAmerica 529 profiled above. Going through an expert certainly has a lot of appeal if you want additional guidance on what to choose, or want to use a more aggressive approach to managing your 529. However, you’ll typically pay heftier fees for advisor-managed accounts.
If you have a long-standing relationship with a particular financial advisor or like to keep all of your investment accounts at one brokerage for simplicity’s sake, it might make sense to open a 529 with them. Many state plans are managed by big-name firms, including the following:
- Ascensus: Alaska, Arkansas, Colorado, Delaware, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Minnesota, Mississippi, Missouri, Montana, Nevada, New Jersey, New York, North Carolina, North Dakota, Pennsylvania, Rhode Island, Washington D.C.
- Fidelity: Arizona, Delaware, Massachusetts, New Hampshire
- Hartford: Connecticut, West Virginia
- Merrill Lynch: Maine
- TIAA-CREF: California, Connecticut, Georgia, Kentucky, Michigan, Minnesota, Mississippi, Oklahoma, Oregon, Vermont, Wisconsin
- T. Rowe Price: Alaska, Maryland
- Vanguard: Iowa
Should I Consider a Prepaid 529?
There are two main types of 529 plans: Investment plans and prepaid tuition plans. Investment plans, otherwise known as college savings plans, are far more common and are the kind of 529 we’ve discussed thus far. With this plan, you simply make after-tax contributions to an investment account, then withdraw these contributions and their earnings tax-free for qualified educational expenses when the time comes.
With a prepaid plan, you’re actually buying a portion of school tuition in advance, locking in current prices. This basically works as a hedge against any future tuition increases. Since skyrocketing college costs show little sign of slowing down, it seems like an attractive option, especially if you want an especially conservative way to put away money for an older child who only has a few years until college.
Unfortunately, prepaid plans are a bit harder to come by these days. In 2014, there were only 11 open to new enrollees, largely because tuition spikes at state schools have made the plans harder to fund.
There are a couple other major cons of these plans:
- First, they’re usually only a good pick for in-state public schools. (If your child decides not to go to an in-state school, you can still get your money out of the prepaid 529; however, it won’t go nearly as far. Exactly how far will depend on the plan’s rules, but the interest you earn will likely be minimal compared to investment plans.)
- Second, prepaid plans sometimes have stricter rules about qualified expenses than investment 529s. Some may cover only tuition and fees, and not room, board, books, or other related costs.
Because of these big limitations, investment plans are a better pick for the majority of investors. However, if you’re still intrigued by the idea of a prepaid plan, be sure to check out our related post on the Massachusetts U.Plan and several other popular prepaid options. Options include the unique Private College 529 Plan, which guarantees tuition at nearly 300 private schools across the country.
The Best 529 Plan is One You’ll Stick With
Regardless of where you put your money, the best 529 plan is one you’ll contribute to regularly and keep your hands off of until your child is off to college. Any tax benefits you receive are a nice bonus.
There is a wealth of information out there that can help you choose the best 529 college savings plan. But because your 529 options vary based on the state in which you live, it can be tricky to hone in on the right option. Talking to a local financial advisor can go a long way towards helping you choose the right plan for based on your location, child’s age and savings goals.
If you want to learn more about 529 plans and saving for college, check out some of The Simple Dollar’s previous articles: Six Common Myths About 529 College Savings Plans, Choosing a 529 Plan, Saving for College With More Than One Kid, or How to Save for Your Child’s College Education.
If your 529 savings won’t foot the entire bill, take a look at the Best Student Loans in 2020, a comprehensive primer on all kinds of federal and private student loans.