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Parents should carefully consider all of their options when opening a 529 plan. The type of 529 plan you select and how the account is set up can affect potential earnings growth, tax benefits and financial aid treatment. Making the wrong decision can be costly and detrimental to a family’s college savings plan.
Here are eight common mistakes to avoid when enrolling in a new 529 plan.
1. Missing Out On a State Income Tax Benefit
Almost every state offers at least one 529 plan, but families should first check to see if their home state offers any income tax benefits for residents. Over 30 states offer an income tax deduction or tax credit for 529 plan contributions, but in most states, residents must use an in-state 529 plan to qualify.
2. Ignoring 529 Plan Fees
Sometimes an out-of-state 529 plan with lower fees is a better value than an in-state 529 plan with an income tax benefit. As a general rule of thumb, families should use a 529 plan with lower fees while their child is young and direct any new contributions to an in-state 529 plan when their child is in high school.
3. Paying Commissions
Families who open an advisor-sold 529 plan through a broker-dealer will generally pay higher fees than if they had opened a 529 plan directly. Some advisor-sold 529 plans include upfront sales charges as high as 5.75% to compensate the advisor for their expertise.
The advisor should recommend a suitable 529 plan share class based on the client’s needs. Generally, Class A shares make the most sense when the beneficiary has a longer time horizon to invest, and Class C shares are suitable for those approaching college age or who are using a 529 plan to pay for K-12 tuition. Some 529 plans offer C to A convertible shares that automatically transition after a set period of time.
There may be an opportunity to reduce fees if an investor reaches certain sales charge breakpoints within a fund manager or the 529 plan is purchased through a fee-only financial planner, such as an RIA.
4. Picking the Wrong Investment Options
529 plans offer different investment options based on risk tolerance and time horizon until college. Families with young children should generally select more aggressive investment options since they have more time to grow their savings and recover from potential losses. As the child gets closer to college, consider shifting allocations toward less risky conservative investment options.
5. Choosing the Wrong 529 Plan Account Owner
A 529 plan can only have one account owner. The account owner, not the beneficiary, has legal rights to the funds in the account. This person can be a parent, grandparent or any other adult who is saving for future education expenses.
It’s important to make sure that the 529 plan account owner has the beneficiary’s best interests in mind. Nothing stops them from being able to change the beneficiary on the account to themselves or another child, or take a non-qualified withdrawal.
6. Saving Too Little
A college savings calculator can help parents determine if they are on track to save enough for a particular college or type of college. A realistic goal for most families is to aim to save one-third of college costs and cover remaining two-thirds can be covered by current income and student loans.
7. Not Automating Contributions When You Open a 529 Plan
Most 529 plans allow families to schedule automatic contributions from a linked bank account or payroll deduction. With automatic investing, parents can take advantage of dollar-cost averaging and minimize volatility in their 529 plan. This “set it and forget it” method is a proven strategy to help parents save more for college.
8. Waiting to Start Saving
Each day parents wait to start saving in a 529 plan they miss out on potential tax-free earnings growth. For example, if a family starts saving when their child is born, about a third of their college savings goal will come from earnings. But, parents who start saving when their child is in high school will have to save six times more per month to reach the same college savings goal.
