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Is a 529 Plan Worth It?

Last updated 03/19/2024 by

Benjamin Locke

Edited by

Fact checked by

Summary:
In most cases, a 529 plan is definitely worth the effort. 529 plans are government-backed savings and investment plans that allow parents, guardians, or family members to save for education while receiving major tax benefits. Although 529 plans can be used for different types of education, most of the time they’re used for a four-year college. To make sure a 529 is worth the effort, it’s important to understand how, when, and where to structure a 529 plan to best finance your child’s college education.
Attending a 4-year university in the United States can be an incredibly expensive endeavor. College costs are going up and will probably continue to do so. Investing money in a 529 plan will not make education costs any cheaper, but it will help you save for them.
529 savings plans are government-backed plans that allow individuals to save for higher education with significant tax benefits. On a federal level, the money is allowed to grow and be withdrawn free of any federal income tax. On a state level, depending on which state, the money can also receive state tax benefits as well. Those who start saving at the right time with the right strategy can make a 529 plan well worth whatever paperwork and hassle that one might associate with it.

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How much does college cost these days?

When deciding on which college or university a student wants to attend, there are some important differences regarding cost. The first difference is if the colleges are public or private. As of 2020, a private college in the U.S. cost around $46,313 annually for a four-year degree, including tuition, room and board, and additional fees.
For public colleges, there is a significant difference between annual out-of-state and in-state tuition. If you live “in-state,” the average college cost in the U.S. was $27,023 as of 2020. However, suppose you want to attend a public university located in a different state than the student resides. In that case, the cost then increases for out-of-state public college tuition and fees.
StatePublic in-statePrivate in-stateOut-of-state
Alabama$20,497.45$27,086.20$26,516.70
Alaska$19,618.75$27,774.07$26,766.68
Arizona$24,016.21$22,652.22$27,417.20
Arkansas$18,223.36$32,387.74$21,459.88
California$23,037.44$51,750.10$32,177.16
Colorado$22,184.97$37,020.11$30,773.06
Connecticut$27,563.51$58,573.98$35,197.43
Delaware$24,357.68$27,406.03$31,581.56
District of ColumbiaN/A$60,830.29$12,704.00
Florida$15,236.90$39,850.12$18,513.52
Georgia$18,553.84$42,802.11$23,167.2
Hawaii$21,853.97$32,125.61$31,773.89
Idaho$16,337.62$14,380.38$24,844.89
Illinois$25,806.17$49,076.11$29,514.76
Indiana$19,985.34$46,504.24$29,532.75
Iowa$19,808.86$44,850.19$27,346.41
Kansas$19,101.05$33,810.97$23,745.44
Kentucky$21,798.84$36,281.25$26,048.39
Louisiana$19,497.76$53,025.37$22,128.07
Maine$20,457.63$54,375.14$28,522.69
Maryland$22,504.07$58,736.75$27,983.65
Massachusetts$27,618.17$64,196.34$31,894.00
Michigan$24,086.39$39,785.37$36,832.05
Minnesota$21,611.47$45,198.02$24,441.75
Mississippi$19,079.99$27,218.92$19,401.85
Missouri$18,733.65$37,082.59$20,877.16
Montana$16,732.33$41,540.57$25,239.13
Nebraska$19,520.10$35,109.91$22,152.04
Nevada$17,986.81$40,471.3$21,678.27
New Hampshire$28,733.78$47,516.51$30,594.06
New Jersey$28,372.09$52,631.85$29,434.87
New Mexico$16,192.75$36,962.22$19,180.76
New York$23,874.62$56,957.95$22,668.89
North Carolina$17,569.15$48,006.88$23,356.82
North Dakota$17,448.83$23,702.49$13,935.99
Ohio$22,387.69$45,869.39$24,829.81
Oklahoma$16,959.53$39,275.29$21,695.36
Oregon$23,582.25$55,132.39$32,067.85
Pennsylvania$27,403.31$56,756.30$30,221.91
Rhode Island$25,591.65$59,321.02$30,871.20
South Carolina$22,789.83$36,234.52$32,852.95
South Dakota$17,298.48$33,605.52$12,866.40
Tennessee$20,359.59$40,037.27$24,786.08
Texas$18,710.73$48,031.76$24,888.80
Utah$14,618.95$15,706.69$21,272.81
Vermont$29,664.52$61,021.48$41,056.59
Virginia$25,074.33$34,747.54$35,831.020
Washington$19,846.24$52,332.50$30,154.50
West Virginia$19,033.69$22,446.16$22,242.20
Wisconsin$17,783.80$46,797.95$25,522.33
Wyoming$14,900.95N/A$14,803.00
United States$21,035.46$45,931.60$27,023.22
Luckily, the government has made several steps to help families deal with the high costs and possible student loan debt. They have done this through things like financial aid and investment plans such as the 529 savings plan to help with a child’s college savings plan.

Incentives to start a 529 plan

Regardless of what university your child chooses, it’s safe to say that you need to start saving for college now. Although financial aid and scholarships are most definitely in the cards for some, a 529 plan offers some great incentives that you may want to consider.

Tax benefits

529 plans are a way to invest money in state-sponsored investment vehicles with significant advantages as long as the money is used for qualified education expenses.
On a federal level, it’s effectively tax-free. The money added to a 529 account grows without federal capital gains tax. Furthermore, income can be withdrawn from the plan with no federal income tax as well.
On a state level, the money can also be a tax deduction from state taxes depending on the state you live in. You can have multiple 529 plans in different states or multiple plans in one state. Depending on where you set up your 529 plan, you may only receive tax benefits from the state where your plan is located.
It must also be understood that a 529 plan works similarly to a Roth IRA or 401(k). This means you pay taxes on your money before it is contributed, including both federal and state income taxes.

FAFSA cap

The Free Application for Student Aid (FAFSA) is a federally sponsored financial aid program focusing on helping students receive financial aid based on their needs. One of the concerns parents or guardians have when setting up a 529 plan is that it might affect their child’s eligibility for financial aid.
When the federal government noticed the potential contradiction, they designated a cap on how much the 529 plan assets would affect a student’s financial aid. To determine federal financial aid, the government reviews the student’s expected family contribution (EFC), which 529 is part of. A larger EFC results in less aid.
However, when the government looks at 529 assets, they cap the 529 savings plan at 5.64% of total assets. This means the funds from a 529 account can only reduce a child’s financial aid eligibility by a maximum of 5.64%

High contribution limits

If you’ve ever invested in a Roth IRA or 401(k), one of the downsides is the contribution limits. 529 plans also have contribution limits, but they are considerably higher.
In some states, such as Missouri, the contribution limits can be as high as $550,000 on an aggregate level. Furthermore, you can contribute to multiple plans in different states with different contribution limits. Thus, contribution limits are not really an issue at all with 529 plans.

Maximum flexibility and diversification

Every state will have a different 529 plan structure and different options for investment. This means that you can diversify across the different 529 platforms that states might offer. If you have multiple children that will attend college at different times, you can use different risk allocations within each child’s plan.
Want to find out which states offer the best 529 plans based on your needs, timeline, and risk appetite? Here are some of our top investment advisor options to help.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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Everyone in the family can contribute

One of the benefits of a 529 plan is that the whole family can contribute. If your child has grandparents or a rich uncle in the picture, they can also contribute to a 529 plan of their choice.
This can be extremely beneficial under gift tax rules as well. If your child’s grandparents invest a lump sum under current rules, the amount is averaged over five years to accommodate the gift tax rules.

Pro Tip

Under current tax rules, if the student takes income from a 529 plan that is not held directly by their parents or guardian, then it could have an adverse effect on their FAFSA application.

Complications with a 529 plan

A 529 plan can offer both parents and their children a great way to finance their higher education goals. Unfortunately, there are some downsides when you use a 529 plan to save for college.

Restrictions on use

529 plans must be used for qualified higher education expenses. This means that the student must prove they are using the 529 funds for K-12 private school, a university degree, or a vocational school.
If the student graduates and there is still plenty of money left in the 529 plan, then it can no longer be used for qualified education purposes. This money will now incur taxes and fees that otherwise wouldn’t be incurred.
IMPORTANT! While you can use 529 funds for a K-12 school, the funds will only cover the tuition costs of this school. If you’re looking to finance more than just your child’s K-12 tuition costs, consider investing in Coverdell education savings accounts.

Only one beneficiary per 529

Under current rules and regulations, 529 plans can only have one beneficiary. This means that if you have several children, they will require different 529 plans. It is possible to “roll over” an existing 529 plan to a new beneficiary, but this can be complicated and involve a lot of paperwork.

Limit on investment options

Since states dictate 529 plans, every state will have different options for investment. However, these investment portfolios do not encompass every single investment possible. Instead, they have structured plans with different fees and risk allocations.
So if, for instance, you love a certain exotic cryptocurrency, you probably won’t be able to invest in that through a 529 plan.

So, is a 529 plan worth it?

The tax advantages of a 529 plan are undeniable. However, these plans aren’t the only option available when it comes to saving for your child’s education. This includes a Coverdell education savings account, Roth IRA, a prepaid tuition plan, and even custodial accounts under either the Uniform Gift to Minors Act or the Uniform Transfers to Minors Act.
With that in mind, 529 plans have a lot to offer students and their parents. Not only do the funds grow tax-free (or tax-deferred, depending on how they are used), but one account may hold significantly more than most investment accounts can. Before deciding on a 529 plan, consider these risks and benefits such an account offers.
WEIGH THE RISKS AND BENEFITS
Here is a list of the benefits and drawbacks to consider.
Pros
  • Federal and state tax benefits
  • FAFSA cap at 5.64%
  • Higher contribution limits than Roth IRAs and 401(k)s
  • Open to contributions from anyone
Cons
  • Can only be used for qualified education expenses
  • Limited to one beneficiary per plan
  • Contributors have limited investment options

FAQs

What happens if I reach the maximum contribution limit?

The contribution limits for most 529 plans are typically high, so you likely won’t need to worry about that unless you have multiple children. However, if this is something that you worry about, it makes sense to open up multiple 529 plans in different states with varying contribution limits.

Will I get penalized if the money in my 529 savings plan isn’t used for college?

Yes, you will be penalized if the money is used for anything other than a qualified education expense. If you withdraw money from your 529 to pay for something other than educational expenses, the money will be taxed as if it came from a regular taxable investment account.

Who can open a 529 account?

While anyone can open a 529 account, the person that ultimately does may impact a student’s financial aid award. That being said, there can only be one beneficiary per 529 account.

Can a 529 plan be used for gifting?

Yes, a 529 plan can be used for gifting. The IRS considers 529 funds to be a form of gift, meaning the funds must remain under $16,000 to qualify for the gift tax exclusion. Fortunately, the IRS averages the contribution over five years, meaning a large account value can still have significant gifting tax advantages.

Key Takeaways

  • 529 plans are government-sponsored plans that allow you to save and invest in a child’s higher education with significant tax benefits.
  • College costs are at an all-time high. Tuition and fees currently run at $38,070 annually for a private school and $27,560 to attend an out-of-state university.
  • 529 plans have big advantages such as tax flexibility, high contribution limits, and the whole family’s ability to contribute.
  • However, 529 plans can also be complicated as there are restrictions on the use of the funds and limited investment options.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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