The 529 Plan of Attack

The 529 Plan of Attack

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What you need to know before starting this popular college savings plan

You don’t need me to tell you that college is ridiculously, crazy-ass expensive. Nor do you need me to lecture you about how important it is to start saving early for your kids’ higher-education costs. But what you do need me to do is let you in on some of the lesser-known problems with 529 plans. Having just kicked my kid out of the nest this past weekend, I had to learn the hard way that these promising plans have some drawbacks.

For those who don’t know what it is, a 529 plan is an investment account operated by a state or educational institution that’s geared to help families save for future college expenses. At first glance, these popular plans seem like a miraculous way to help you save for the high cost of education. You simply put your pretax funds into your account and invest them in the stock market. You make contributions every year and sit back and watch your balance grow along with your child. Then, once your child is accepted into his future alma mater, you begin withdrawing those funds to help pay for expenses without being taxed on the principal or interest. Who doesn’t like all that tax-free money? Well, me, for one. That’s because, like the surprisingly high-calorie count of a fat-free muffin, things aren’t always as they appear.

Don’t get me wrong. I’m in favor of anyone saving for their kids’ education, and the earlier the saving starts, the better. The sooner you stash away those funds, the less you have to put away each year, making college far more affordable. Personally, I’d start before conception. In fact, in lieu of wedding gifts, ask for college donations. What joy does a chafing dish bring when there are future chemistry books and extra-long twin-sheet sets to buy? So although I’m in favor of 529 plans in general, I want to let you in on some of their limitations so you can make an informed decision.

To begin with, since a 529 plan is linked to the market, there is no guarantee it will be worth more over time. We all saw the financial devastation that occurred when the bubble burst in 2008 so, although it’s a slight one, there is a chance that you could have less money than you invested when it’s time to make your withdrawals. Also, even though you don’t pay tax on this money, you do pay fees, which can sometimes be more than your portfolio earns.

In addition, when your kid gets accepted to the college of her choice and it’s time to fill out those horrible and confusing financial-aid forms (such as the dreaded FAFSA, or Free Application for Federal Student Aid), the money in your child’s 529 plan is declared, which means having a 529 plan can reduce the amount of financial aid that your child might have been given otherwise.

And what if your kid either doesn’t go to college or drops out, leaving you with a chunk of 529 funds? Or what if you mistakenly use your 529 plan savings for something that’s not an actual, approved college expense? If you use those savings for anything but approved college costs, you will have to pay not only tax on that amount but also penalties.

So what can you, a hardworking, loving parent whose only goal is to help your child get a college education, do? Get an education yourself. The more you know about 529 plans, the better. For instance, did you know that if you put the 529 plan in your child’s name, he will be qualified for less financial aid than if the plan were in your name? And did you know that different states offer different 529 plans? And because the funds are tied to the market, did you know it’s crucial to start saving early so that the market has time to correct itself if something happens? And just as crucial is to check to see if your college expenses are approved, so you aren’t paying unforeseen taxes and penalties.

Since everyone’s situation is different, it’s important to also check with your financial planner before making any decisions. You should know what you’re getting into so you have a better chance of getting something out of your well-meaning investment. A 529 plan can certainly be part of a strategic college savings plan, but be sure to do your research before putting all your financial eggs into one tax-free basket.

Joanne Kimes, ESME’s Parenting Resource Guide, is the writer and creator of the best-selling Sucks book series (some titles include Breastfeeding Sucks, Potty Training Sucks, and Teenagers Suck) and coauthor of The Stay-At-Home Martyr. She has contributed to numerous blogs and magazine articles, and has appeared on NBC’s Today show, Life & Style, and KTLA news.

Please feel free to contact us with any comments or questions.

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