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.