8 common 529 plan mistakes to avoid

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Kathryn Flynn

By Kathryn Flynn

August 27, 2018

1. Not using a 529 plan to save for college

If you’re not using a 529 plan to save for college, you could be missing out on:

  • Federal tax-free earnings growth
  • Tax-free withdrawals
  • State tax deductions or credits on contributions
  • Full control of the funds in the account
  • No income or annual contribution limits

2. Not considering 529 options from every state

  • You can open a 529 plan in any state, no matter where you live.
  • The beneficiary can use the funds toward college expenses in any state, no matter where you purchased the plan.
  • Start by looking into your own state’s plan, many offer special tax incentives for residents.
  • However, don’t ignore other options from other states that may have lower fees and expenses.
  • Savingforcollege.com offers an easy way to research plan options by state.

3. Forgetting about fees

  • While 529 plan fees have been declining in recent years, if you’re not careful they can still eat away at your investment returns.
  • The average fees charged by a direct-sold 529 plan are around 0.54% (1.47% for broker-sold plans) and include:
    1. Maintenance and administration fees
    2. Expenses of the underlying investments
    3. Sales charges for broker-sold plans
    4. Account maintenance fees
  • Our 529 Fee Study can help you compare costs to find the best plan to suit your needs.

4. Failing to give your account regular checkups

  • Age-based portfolios will automatically shift your investment allocations to appropriate asset classes based on the age of the beneficiary (think: stocks for young children and less risky fixed-income investments as college gets closer).
  • If your plan doesn’t offer an age-based option, you’ll have to make the adjustments yourself or with the help of your financial advisor.
  • You should also adjust your contributions if there have been any updates to your family situation such as a change in household income or more children to save for.

5. Counting on scholarships

  • While many students do receive athletic and academic scholarship awards, it’s usually not enough to cover the full costs of college.
  • NCAA athletic scholarships are only awarded to around 2 percent of high school students.
  • The average amount awarded by the NCAA is only $11,000, which typically wouldn’t even cover one year of tuition.
  • Even if you feel strongly that a scholarship is in your future, it’s best to play it safe by saving with a 529 plan to cover any leftover balance.
  • In the event that the funds are not needed, the earnings portion of a nonqualified withdrawal made up to the amount of the scholarship will avoid the 10 percent penalty tax, but the earnings portion will still incur income tax.

6. Not counting on scholarships

  • According to the College Board, about two-thirds of students receive grants or scholarships with an average amount of over $12,000.
  • While there is no guarantee that any student will get a scholarship, it’s important to keep the possibility in mind when planning your savings strategy.
  • Use our college cost calculator to estimate what your future costs will be. Try not to overfund your 529 account since the earnings portion of any non-qualified withdrawals will incur income tax as well as a 10 percent penalty.

7. Taking non-qualified withdrawals

  • Qualified expenses include:
    • Tuition for any eligible institution, including some summer school classes, study abroad programs, community college classes Books
    • Supplies and equipment needed for course enrollment
    • Equipment required for special needs students
    • Some room and board, as long as the student is enrolled at least half time
    • Be careful not to “double dip” if you or the beneficiary are claiming the American Opportunity Tax Credit or Lifetime Learning Credit.
  • The earnings portion of all non-qualified withdrawals will incur income tax and be subject to a 10 percent penalty.
  • There are exceptions to the 10 percent penalty, including when a student receives a scholarship, dies or becomes disabled or chooses to attend a U.S. military academy.

8. Procrastinating

  • It’s never too early (or too late) to open a 529 account.
  • If your child isn’t born yet, you can open an account in your own name and change the beneficiary later. A child’s first year is a perfect time to ask friends and family to help. Contributions to a college fund make great baby shower, baptism and first birthday gifts.
  • With 529 plans, waiting to save could cost you significantly:
  • With today’s college inflation rate at 4%, in 10 years the average four-year public school is expected to cost over $145,000.
    • If you start saving immediately, you will need to make monthly contributions of around $665 to cover the total costs (assuming a 6% annual return).
    • However, if you wait just two years to start making contributions, that number jumps to $840.
    • Plus, since you missed out on tax-free earnings growth over the last two years, you would end up having to contribute a total of $7,000 more over the life of the plan.

A good place to start:

See the best 529 plans, personalized for you