What Are the Pros and Cons of Using a 529 Plan?
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By Kathryn Flynn

February 9, 2021

Paying for college is a major expense. For some families, a four-year degree could end up costing more than a small home. The best way to prepare for future college costs is to save for college. There are a number of different savings plans for college, but in recent years 529 plans have been growing in popularity among families.

If you’re thinking about opening a 529 plan for a child or grandchild, it’s important to understand 529 plan rules and how they work. Here are some advantages and potential disadvantages of 529 plans to consider.

Advantages of Using a 529 Plan

Disadvantages of Using a 529 Plan

  • Federal income tax benefits, and sometimes state tax benefits
  • Funds must be used for education
  • Low maintenance
  • Limitations on state tax benefits
  • High contribution limits
  • No self-directed investments
  • Flexibility
  • Fees
  • Favorable financial aid treatment
  • Ownership rules 


Advantages of using a 529 plan to save for college

529 plans offer tax-advantaged savings for education

529 plan investments grow on a tax-deferred basis and distributions are tax-free when used to pay for qualified education expenses, including college tuition and fees, books and supplies, some room and board costs, up to $10,000 in K-12 tuition per year and up to $10,000 in student loan repayment per beneficiary and per sibling.

Qualified 529 plan distributions are also excluded from state taxable income, and many states offer a state income tax deduction or state income tax credit for 529 plan contributions. 529 plans are the only college savings plan to offer state tax benefits. 

States may have residency requirements for tax benefits, but families are not restricted to using their home state’s college savings plan. An exception may be if they are using a prepaid tuition plan. 

529 plans are low maintenance investment accounts

A 529 plan account can be opened online or through a licensed financial advisor. Families who prefer to “set it and forget it” can select an automatic investment plan linked to a bank account or payroll deduction plan. The ongoing investment management within a 529 plan is handled by the program manager.

529 plans have high maximum contribution limits

Unlike other savings plans, such as a Roth IRA or Coverdell Education Savings Account, 529 plans have no annual contribution limits and high aggregate limits. Maximum aggregate limits vary by state, ranging from $235,000 to $529,000.

529 plan contributions are considered completed gifts to the designated beneficiary for tax purposes. Up to $15,000 qualifies for the annual gift tax exclusion. There is also an election to contribute as much as $75,000 in one year without generating a taxable gift if the contribution is treated as if it were spread over five years.

Parent-owned 529 plans get favorable financial aid treatment

529 plans owned by a dependent student’s parent or a dependent student are reported as parental assets and have a relatively minimal effect on financial aid eligibility. Distributions from a 529 plan owned by a dependent student’s parent or a dependent student are not counted as income on the Free Application for Federal Student Aid (FAFSA).

529 plans are flexible

529 plans offer the same benefits for all families, regardless of their household income or the amount they contribute. You can invest in almost any 529 plan, no matter where you live or where you child will attend college.  

Disadvantages of using a 529 plan to save for college

529 plan funds must be spent on qualified expenses to avoid tax and penalty

Non-qualified distributions are subject to income tax and a 10% penalty on the earnings portion of the distribution. However, there are exceptions to the penalty if the beneficiary gets a scholarship, attends a U.S. Military Academy, dies or becomes disabled.

State income tax benefits may be recaptured if you switch 529 plans 

If a 529 plan account owner does a rollover into another state’s 529 plan, any state income tax deductions and credits previously claimed may be subject to recapture, and the earnings portion of the outbound rollover may be added back to state taxable income.

Some 529 plans offer limited investment choices

A 529 plan account owner must select from a menu of investment options offered by the 529 plan. This typically includes static investment portfolios that aim to achieve a targeted level of risk, individual fund portfolios and age-based portfolios that automatically shift asset allocation as the beneficiary gets closer to college.

Some 529 plans have high fees

The more families pay in 529 plan fees, the less they are able to save for college. Direct-sold 529 plans are less expensive than advisor-sold 529 plans, but expenses can also vary among 529 plan portfolios. It’s important to research your options and find a low-cost 529 plan option that meets your college savings needs.

529 plans owned by a third-party can hurt financial aid eligibility

A 529 plan owned by a grandparent or anyone other than the student or parent is ignored on the FAFSA (but may be considered on the CSS Profile). However, distributions from a 529 plan owned by a third-party are counted as untaxed income to the student and can reduce the student’s eligibility for financial aid. To avoid this negative impact, grandparents can time the 529 plan distribution so that it is not counted on their grandchild’s FAFSA. Be sure to discuss your college savings plan with a child’s parents or grandparents. 

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