7 myths and realities of 529 plans

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Kathryn Flynn

By Kathryn Flynn

August 27, 2018

Although they’ve been around for years and continue to gain popularity, there are still many common misconceptions about 529 college savings plans. Here are our responses to 7 of the most popular myths:

Myth 1: If my child doesn’t go to college, I lose all the money in my account.

Reality: You will never lose all of the money. Here are some options:

  • Use the funds to pay for community college, vocational school or other eligible post-secondary education.
  • Change the beneficiary to a sibling or other qualifying family member who will attend college.
  • Use the money to pay for your own continuing education.
  • Save the funds for a future grandchild.
  • Take a non-qualified withdrawal and pay income tax and a 10% penalty on the earnings portion of the withdrawal. Your contributions were made with after tax money and therefore will never be taxed or penalized.
 
 

Myth 2: If my brilliant or athletic kid gets a full ride, I lose the money in my account.

Reality: Again, you will never lose all of the money. Here’s why:

  • When you take a non-qualified withdrawal from a 529 plan, you will incur income tax and a 10% penalty on the earnings portion of the withdrawal. The principal portion will never be taxed or penalized.
  • But there’s a special exception to the 10% penalty when the beneficiary dies, becomes disabled, decides to attend a U.S. Military Academy or earns a scholarship.
  • Students can avoid the 10% penalty on non-qualified withdrawals up to the amount of the tax-free scholarship. The earnings portion of the withdrawal, however, will still incur income tax.
 

 

RELATED: Scoring an athletic scholarship

Myth 3: I can only invest in my home state’s plan.

Reality: You can enroll in almost any state’s 529 plan, no matter where you live, but:

  • Check with your home state’s plan first
    • Currently, 35 states including the District of Columbia, offer a state tax credit or deduction for 529 plan contributions.
    • Most of these states require that you invest in your home state’s plan, but seven states will offer a tax benefit for contributions to any state’s plan.
 
 

Myth 4: My child can only go to college in the state where the plan has been set up.

Reality: Your child can attend almost any college, no matter where your 529 savings plan is based.

  • This includes four-year public and private colleges, community college, trade schools and even some international schools.
  • You can check to see if your school is an eligible institution for purposes of Section 529 with Savingforcollege.com’s Federal School Code Lookup.

 

Myth 5: Only young people can have 529 plans.

Reality: There are no age requirements for a 529 plan beneficiary.

  • Younger children will have more time for their investments to grow in a 529 plan, but older students can still take advantage of federal and sometimes state tax benefits.
  • For example, if a student lives in a state that offers a tax deduction for 529 plan contributions and they are going back to college for a career change or graduate school, they can claim the deduction and reinvest it for a quick boost in savings.
 

 

 

Myth 6: I won’t get financial aid if my child has a 529 account.

Reality: A 529 plan will affect financial aid eligibility, but the impact will be very small.

  • 529 accounts owned by a student or one of their parents receive favorable treatment on the FAFSA.
  • Typically, 20% of a student’s assets are considered available funds to pay for college.
  • But money saved in a student-owned 529 plan is considered a parental asset, which means student’s aid package would only be reduced by up to 5.64% of the account value.
  • What’s more, you will not have to report the funds withdrawn as student income on the FAFSA when they’re used to pay for college.
    • Withdrawals from other savings vehicles, such as Roth IRAs, will be counted as student income and are assessed at up top 50%, so a $10,000 withdrawal can reduce a student’s aid eligibility by $5,000.
  • Wondering how your 529 plan may impact financial aid? Use our Financial Aid Calculator to estimate the expected family contribution (EFC) and your financial need.

 
 

 

Myth 7: My income is too high to contribute to a 529 plan.

Reality: Unlike other education savings accounts and some retirement accounts, 529 plans have no income limits.

  • For example, married couples filing jointly with a Modified Adjusted Gross Income (MAGI) of $183,000 or less ($116,000 or less for individuals) can contribute the maximum amount of $5,500 to a Roth IRA for 2015.
    • Couples with an MAGI greater than $193,000 ($131,000 for individuals) are ineligible for a Roth IRA.
  • Those with adjusted gross income is $110,000 or more ($220,000 if filing a joint return), would not be eligible to use a Coverdell ESA in 2015. Your ability to contribute up to $2,000 for any child is reduced on a ratable basis as modified AGI rises above $95,000.
 
 

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