When Does a 529 Plan Make Sense (and When Doesn’t It)?

Damian Winther, CFP® CSRIC™
Aug 25, 2020 11:00:00 AM

When Does a 529 Plan Make Sense (and When Doesn’t It)? – Birchwood FP

The cost of a college education continues to skyrocket and many families are astounded by the price tag and sticker shock, which they often fail to look into until it’s too late. As a financial advisor, I work with clients that have young children (and grandchildren) to carefully evaluate the pros and cons of saving money in a 529 plan for future college expenses.

Advantages of a 529 College Savings Plan

A 529 college savings plan offers several key tax advantages for today’s younger generations and families. Some of the key tax benefits include the following:

  1. Tax-Free Growth
    As long as distributions are used for qualified higher education expenses, the growth inside the 529 plan is eligible for tax-free distribution. If non-qualified distributions are taken, the growth portion of the 529 plan is subject to ordinary income tax, plus a 10 percent penalty.
  2. Tax-Free Return of Principal
    You can always take out what you’ve contributed to a 529 plan (i.e. basis or principal) without taxes or penalty. This is a key benefit to individuals and families that may find themselves in a financial hardship situation, without access to other sources of liquidity.
  3. Up to $10,000 to Payoff Student Loans
    This is a new 529 plan benefit, which gives account owners the ability to use $10,000 from within the 529 plan to pay down student loans.
  4. Rollover Plan to Family Members
    Money in a 529 plan can be rolled over to a new 529 plan for eligible qualifying family members. Eligible family members include spouses, siblings, children, aunts, uncles, nieces, nephews and first cousins. This is a great source of flexibility, particularly if the 529 plan beneficiary chooses not to go to college. 
  5. Potential Growth
    If the 529 plan beneficiary is young, you have the added benefit of time being on your side. This is a fantastic planning opportunity since it creates more time for potential growth on a tax-free basis.
  6. Deductions and Credits
    Some states offer income tax deductions and credits if contributions are made to the resident state’s 529 plan. Depending on your primary state of residence, this may or may not be an important reason for utilizing your in-state 529 plan.

Other Considerations

From the examples outlined above, it may seem like a 529 plan is the ideal choice when it comes to paying for college, but is that always the case? Generally speaking, the answer is ”it depends”. Here are some key reasons why:

  1. I stress to clients the importance of saving for retirement. A common saying in the investment industry is, “You can borrow for college, but you can’t borrow for retirement.”
  2. Roth IRAs - we strongly encourage max funding of tax-free retirement accounts before money is added to a 529 plan. An example of this is a Roth IRA, which individuals are able to contribute to, assuming their Adjusted Gross Income is less than certain thresholds.
  3. Take advantage of the employer match in your company retirement plan. Many individuals fail to fund their employer sponsored retired plan at a level that will generate the full matching contribution. At a minimum, we encourage funding the workplace retirement plan at whatever contribution is necessary to receive the full match. This is free money!
  4. Beneficiary’s age – if the 529 plan beneficiary is older and therefore doesn’t have time on their side for the benefits of potential growth to take effect, consider keeping money outside of the 529 plan and/or utilizing a 529 plan that offers a guaranteed return, such as CDs or insured deposits.

Financial situations vary from person to person and family to family. Funding long-term investment portfolios is something that should be based on a series of decision factors and priorities. There is never a one-size fits all approach to achieving goals and it’s for that reason that we work with clients to help them outline a roadmap and plan.

New call-to-action

Investment Advisory services offered through Birchwood Financial Partners, Inc. an SEC Registered Investment Advisor.

All written content is for information purposes only. It is not intended to provide any tax or legal advice or provide the basis for any financial decisions. Opinions expressed herein are solely those of Birchwood Financial Partners, Inc., and our editorial staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser or qualified professional before making any financial decisions. We are not affiliated with or endorsed by the Social Security Administration or any government agency. The inclusion of any link is not an endorsement of any products or services by Birchwood Financial Partners. All links have been provided only as a convenience.