Saving for college can be scary, but 529 Plans can help remove some of the angst. After all, they’re a flexible investment whose gains are tax-free when used for college. But even if you think this is the best way to fund your child’s college education, your mind goes into parent ‘worst-case scenario’ mode. “What if 2008 happens again?” “What if I move?” “What if my kid doesn’t go to college?” These are reasonable inquiries and I get them all of the time. So let me go through the most common questions I hear from my clients and see if I can help quell your concerns.
“I live in State X, what if my kid wants to go to school somewhere else?”
This is absolutely no problem. 529 Plans are extremely flexible. The beneficiary of the Plan can go to virtually any accredited school in the United States as well as some universities abroad, regardless of which state’s 529 Plan you have. You can live in North Carolina, open up a Nevada 529 Plan, and send your kid to school in Michigan. Even if you have a prepaid 529 Plan in a particular state, your child can attend school somewhere else. You will just have to pay the difference if the college attended costs more in tuition than the prepaid Plan’s state.
“My child is a certified genius and he/she will most likely get a scholarship. What happens then?”
As a parent, you always want to believe that your child is going to get a full ride to the college of his or her choice. However, that expectation should not stop you from putting away money. A scholarship might only cover tuition. 529 Plans can be used to cover tuition, books, supplies, room and board and anything else required by the university to attend. If your child ends up receiving a scholarship, you can remove the value of the scholarship from your 529 Plan without penalty. You will just owe normal taxes on the gains.
“My investment in a 529 Plan could lose money! Shouldn’t I be worried?”
Yes, in most 529 Plans there is a risk of loss since you are invested in things like stocks and mutual funds. However, there are plenty of ways to guard yourself from market downturns. First, be sure to choose an investment portfolio that you are comfortable with. Some are risky, but offer more room for growth and vice versa. You can also add peace of mind and simplify your investment by choosing an age-based portfolio. These investments inherently have more risk and growth potential when the beneficiary is young and automatically are placed into more conservative fixed-income funds as the child gets closer to college. Finally, you can use the power of dollar cost averaging, a simple investing strategy that requires you to invest a constant amount of money every month. 529 Plans are not for everyone. Some prefer the safety of a savings account, but remember, the cost of college is increasing at a far higher rate than the likely sub-1% return you’ll see from a savings account.
“What if my child doesn’t go to college?”
I hope everyone’s child goes off to college. I think it’s an experience everyone should get to have, but the fact is, not everyone will. If this were to happen, there are options. First, you could change the beneficiary to any qualified family member. Secondly, this account can be kept into perpetuity. So, let it grow and when you have grandchildren, name them the beneficiaries. Finally, have you ever wanted to go back to school? Not in the Rodney Dangerfield sense, but to pursue an education you didn’t have time for before? Name yourself as the beneficiary and get that degree you’ve always wanted! If these options do not work for you, you can still remove the money from the account. Only the earnings (not the principal) will be subject to income tax as well as a 10% penalty.
“This is a pretty long-term investment. What if I’m not happy with the Plan I choose?
This isn’t a problem. Current rules allow for you to rollover (switch) 529 plans once every rolling 12 months and your investment allocation twice every calendar year. But there are some things to keep in mind. If you’re in a Plan which has allowed you to take state tax deductions, you may have to pay those back if you rollover to another state’s Plan. Some states even treat outbound rollovers as non-qualified withdrawals subject to a penalty! But the best Plan for you could change year-by-year, so I always suggest to my clients a yearly check-up. If you’re in a Plan with no harsh rollover penalties, you might as well switch and be in the best Plan for you every year.
“How will this affect my child’s ability to receive financial aid?”
This is one I get a lot. The Internal Revenue Code (which houses the language that make 529s possible) is written to encourage certain behavior. Section 529 was designed to encourage families to save for college. If putting money into a 529 killed your ability to obtain financial aid, it would have made this all futile. 529 Plans actually have a very minimal impact on financial aid. Accounts held in the name of parents or a dependent student are assessed at a maximum of 5.64%. This means if you have $10,000 in a 529 Plan, your financial aid package will be reduced by a maximum of $564. However, be careful if you’re a grandparent and the account owner of a 529 Plan. Although it does not count as an asset for financial aid purposes, money used for the grandchild can count as unearned income and can severely hurt financial aid. If you’re unsure about how this could affect your situation, talk with a financial advisor who’s familiar with 529 Plans.
“There are so many 529s to choose from! How do I know which one is best for me?”
Well just like most things these days, almost everything you need to know is available somewhere on the Internet. Some 529 Plans are good, some are mediocre and some are terrible. So choosing the right one is critical. You want a 529 Plan with low fees and high returns, not the other way around, right? So do your due diligence. Check to see if you get tax deductions. Analyze the historical performance of Plans. Check reliability to see whose program managers have been around the longest. Assess the 1000+ investment portfolios to choose one that suits your risk tolerance. Or, tell your employer about Gradvisor and let us do the work for you!