What You Need To Know About 529 Plans

By Steve Barlotta, CPA

A 529 Plan can be a great option for saving for a child’s college education. Contributions to these plans are allowed to grow tax-deferred, and withdrawn tax-free if used for qualified education expenses. These features make a 529 Plan very attractive to parents or grandparents that want to maximize the growth of their college savings. But, there are some downsides to 529 Plans that you should be aware of.

I have met with parents that send their children to private high school and they have frequently asked me if they could utilize a 529 Plan. The one disadvantage is that distributions from 529 Plans for pre-college expenses are not considered qualified expenditures and are not allowable.

All of the 529 Plans that I’m familiar with are managed by a mutual fund company for a particular state plan. So, your investment choices will be limited to the available funds that the mutual fund company offers. Additionally, most mutual fund companies limit the amount of funds available in their 529 Plans.

While many states like New York allow a tax deduction for 529 Plan contributions, New Jersey does not. Also, keep in mind that there is no federal tax deduction for putting money into a 529 Plan because contributions are made with after-tax dollars.

In my opinion, the biggest downside of the 529 Plan is that you are permitted to change your investment strategy only once in a 12-month period. As we saw in the 2008 – 2009 financial market meltdown, many investor’s savings, including 529 Plans, were drastically slashed. I feel the volatile nature of today’s financial markets make it unrealistic to allow parents or grandparents to only make investment changes once a year. Exceptions to this rule are made if you move your 529 assets from one state’s plan to another, or roll the plan over to a new beneficiary.

The advantages of a 529 Plan far outweigh the disadvantages, but it is important to know the limitations of these plans before going forward with this significant investment. If used properly, a 529 Plan can be an effective tool in saving and paying for a college education.