I Just Opened A College Savings Account For My Daughter, And This Is Everything I Learned In The Process (2024)

FAQs

Why are 529 plans a bad idea? ›

One of the main drawbacks of saving in a 529 plan is that you owe a penalty if you use the funds for an ineligible expense. If you do need to withdraw funds or use them for noneducation-related expenses, you'll incur a 10% penalty and owe taxes on any investment gains.

You can transfer the funds to another eligible beneficiary, such as another child, a grandchild, yourself or a friend. If you just want the money back, you can withdraw the funds at any time.

There is no annual limit on how much you can withdraw for college expenses, but there are limits on certain expenses. An annual withdrawal limit of $10,000 is applied to 529 plans for K-12 tuition expenses. If you're using 529 plan funds to pay student loan debt, there is a lifetime withdrawal limit of $10,000.

Leave the account intact.

If your child is simply not sure about college or perhaps wants to delay applying, you can keep your 529 plan intact until the child does use it for qualified education expenses.

Some 529 alternatives include using a custodial account, Roth IRA or Coverdell Education Savings Account.

For in-state, four-year, public college: minimum $300 per month. For out-of-state, four-year, public college: minimum $500 per month. For private, non-profit, four-year college: minimum $650 per month.

Coverdell ESAs have an annual contribution limit of $2,000. That's considerably less than you can contribute to 529 plans. Most 529 plans have lifetime contribution limits of $350,000 and up (limits vary by state). Coverdell ESAs also have income restrictions on who can open an account.

Most families plan to save about a third of future college costs for each child. On average, however, families save only about 10% of college costs when the child turns 18, falling short of the goal.

In most states, that means age 18, though in some states the age threshold may be higher. The custodian can't change the beneficiary or account owner. Once the account owner/beneficiary becomes an adult, they assume control over the 529 plan.

Can you use a 529 for something other than college? ›

529 plan funds can be used to pay for trade or vocational courses as well, as long as the school or teaching institution is eligible for federal student aid. You can check online to see if the school participates in the U.S. Department of Education's federal student aid program.

If you have a clear investment strategy or don't want to mingle funds from different sources then having multiple plans might make sense. Most of the time, however, it makes more sense to have a single 529 plan per child.

The grandparent loophole allows grandparents to use a 529 plan to fund a grandchild's education without affecting the student's financial aid eligibility. Previously, withdrawals could have reduced aid eligibility by up to 50% of the amount of the distribution.

But have you ever wondered what happens to unused 529 funds? You have two options: Withdraw the money or save the unused 529 plan funds for future qualified education expenses. Don't worry; leftover 529 money is common, and you can still make the most of the funds after graduation.

In each year you take withdrawals from a 529, the plan administrator should issue a Form 1099-Q, which reports the total distribution taken from the account in a given year, the portion of the distribution that came from earnings in the account, and the portion of the distribution that represents the original ...

Must only be used for education

Only certain education expenses qualify, so you need to make sure you're withdrawing money for qualifying expenses to avoid taxes. If you use 529 savings plan funds for non-qualified withdrawals, they may incur a 10% penalty. And they may be subject to federal income tax.

You might easily trigger a penalty

The most important one is this: you must use funds in a 529 account to pay for qualified educational expenses. Otherwise, you'll owe taxes on the investment gains at whatever the IRS would normally charge you plus an additional penalty rate of 10 percent.

It's easy to see why Americans don't embrace 529 plans. They often have limited investment options, high fees, complicated rules and anxiety-producing investment risks. All that said, the plans may ultimately be worthwhile for most families, as long as parents choose carefully. Focusing on fees is crucial.

With the new regulations, 529 plan account owners or beneficiaries can roll over 529 funds into a beneficiary-owned Roth IRA tax-free and penalty-free as of January 1, 2024, subject to the limitations described below. If you qualify, this can be a great way to help kick start a beneficiary's retirement savings.