Why a 529 College Savings Plan Matters

If you’re a parent (or plan to be), one of the biggest financial questions you’ll face is: how on earth am I going to pay for my kid’s education? Between tuition, housing, books, and even K-12 private school costs, it adds up fast.

That’s where the 529 College Savings Plan comes in. In my opinion, it’s one of the smartest, most tax-efficient ways to save for your child’s future. And while there are a few different ways to save for kids (check out my blog on the top 3 strategies), the 529 Plan is often the best option IF college or education is the main priority and goal.

What Is a 529 College Savings Plan?

A 529 College Savings Plan is a tax-advantaged investment account designed to help families pay for education expenses. Almost every state offers one, and there are also options from providers like Vanguard or Charles Schwab if your state doesn’t have a 529 offering. 

The best part? You don’t have to live in a certain state to open that state’s plan, you can shop around for the one that makes the most sense for you. 

Pros of the 529 Plan:

Tax Free Growth & Withdrawals

All of your future earnings within the account grow tax free and future withdrawals are tax free SO LONG as the withdrawals are used for qualified education expenses (tuition, books, housing, meal plans, etc.).

If the funds are not used for education expenses, you will trigger a 10% penalty and will be taxed on the earnings portion of your withdrawal. (You will not be penalized or pay tax on your original contribution amounts – only the earnings).

In State Tax Benefits

If you are a resident of a state and you open and contribute to that particular state’s 529 College Savings Plan, many (but not all) states will provide you with either a state tax credit or deduction on your state tax return. Each state credit or deduction is different. This is something you will want to consider when comparing different 529 Plans to invest in.

You Remain in Control of the Funds

The owner of the account (that’s you) will remain in control. The beneficiary or student has no legal rights to the 529 account and will not have access to take out withdrawals or make investment decisions.

No Time Limit

The funds invested in the 529 account are not required to be withdrawn within a certain time period. Your funds don’t “expire”. If your child doesn’t need the money, you can keep growing the account, change beneficiaries (say, to another child or even a grandchild), or now… roll some into a Roth IRA (more on that below!).

Easy to Set Up & Low Maintenance

Most state plans are simple to open online. Many even offer age-based portfolios, which adjust investments automatically as your child gets older or low cost index funds options to keep your costs low.

Cons of A 529 Plan:

Investment Options are Limited

As stated above as a pro, depending on who you ask, the investment options tend to be more limited and you do not have access to invest in whatever it is that you want. There is a specified list of investments to choose from. Depending on your style, this could feel restrictive.

Fees Can Be Steep

State sponsored 529 College Savings Plans fees range anywhere from 0.25% to 1.5%. This will be an important number to know before agreeing to open an account in any one particular state as the fees eat into long term growth.

New from the Secure 2.0 Act: 529 to Roth IRA Rollovers

One of the biggest updates to 529s is the ability to roll over up to $35,000 of unused funds into a Roth IRA for the beneficiary.

Here’s what to know:

• The 529 must be open for at least 15 years.

• Annual rollover amounts are subject to the Roth IRA contribution limit.

• This is a lifetime rollover cap (not per year).

This is a game changer because it means unused 529 money doesn’t have to go to waste, it can end up helping the beneficiary for their future AND it maintains its tax free growth nature.

FAQs About 529 College Savings Plans I’ve Answered Over the Years

1. What happens if you move?

You can continue to invest in the 529 account as is or you may have the opportunity to roll it over into a new 529 plan if you choose to do so. If you continue to contribute to the old 529 plan and are no longer a resident of that state, you may no longer receive the state tax benefit for your contributions. Worth considering rolling over into a new state plan in which you reside (depending on fees & state tax benefits offered).

2. Are your kids required to go to a specific college or attend a state university within the state 529 college savings plan you are contributing to?

No. Funds can be used at any eligible U.S. (and even some international) schools.

3. Can I transfer the 529 account or change the beneficiary?

Yes. If your named beneficiary on the 529 account chooses not to go to college or does not use all the funds, you are able to change the beneficiary to another individual within the family.

4. Do I have to contribute and invest in my state’s 529 Plan?

No. You may opt to open a 529 account in any state you wish (or go through Vanguard, or another institution that offers their own). When comparing 529 plans – look at the fees, the in state tax benefits & past performance.

5. What happens if my child gets a full scholarship?

(Please be mine!!) You are able to withdraw the same amount of funds as the scholarship from the 529 and use for non-educational expenses penalty free. You will only be responsible for paying the tax on the earnings from the withdrawal.

6. What are the Exceptions to the 10% Penalty for Non-Qualified Withdrawals?

If any of the below become relevant to the beneficiary of the 529, the 10% penalty may no longer apply. If the beneficiary….

• Becomes incapacitated

• Attends a U.S. Military Academy**

• Receives educational assistance through an employer provided program**

• Receives a tax free scholarship**

**You may withdraw funds from the 529 Plan in the amount of said military academy tuition, tax free scholarship or employer provided education assistance. Any withdrawal in excess of those amounts may be penalized.

A Few (not all) Examples of Qualified Education Expenses:

• College tuition & fees

• Vocational and trade school tuition and fees

• Room & board fees

• Off campus housing (up to the cost of room & board fees)

• On campus meal plans

• Books & supplies

• You are able to take tax-free withdrawals of up to $10,000 (per year, per beneficiary) for K-12 tuition expenses

• $10,000 student loan payoff (lifetime limit, not per year)

Two Outside Resources Worth Sharing:

Vanguard has its own 529 Plan offering as well and it’s biggest draw is the low fee structure. To compare the Vanguard 529 and your other state sponsored 529 plans, please click on this Vanguard link to see which offering makes the most sense for you.

Another great resource for commonly asked questions and state by state comparisons as it relates to the 529 college savings plan is the the Saving for College website.

Final Thoughts

If you’re serious about setting your kids up for educational success, a 529 College Savings Plan is one of the best tools out there. It’s flexible, tax savvy, and now even has a built in backup plan with the Roth rollover.

My advice? Start small, start early, and let compounding do the heavy lifting. You don’t need to save it all at once, nor can most of us, just begin with consistent contributions which will make a huge difference over time.