5 Disadvantages of 529 Plans
For many, the 529 plan is an excellent vehicle for college savings. And with good reason- its tax-free withdrawals and high contribution limits are tempting benefits that make it stand out against similar investment options. Despite these benefits, some parents find themselves hesitant, given other options like UTMAs and UGMAs. This is within good reason- you should never settle for your child’s future. Though we think the 529 plan is an excellent choice with several advantages, here are 5 reasons why some people have second thoughts.
1. It Counts Against You on FAFSA
Planning on financial aid? With the 529 plan, you might have to plan for disappointment. The FAFSA- or Free Application for Federal Student Aid- determines how much financial aid your child will receive for college, based on things like income and assets. Many families depend on FAFSA to help them afford the rising price of college. If your financial situation necessitates aid, you should keep in mind that the 529 plan can count against you on the application for your expected family contribution, as it is considered an asset. This doesn’t necessarily rule out the 529 as an option, as there are many benefits that outweigh this drawback- it’s just something to consider.
2. Penalty
The 529 plan is praised for its tax-free benefits, but these only apply if you make withdrawals for eligible expenses. An ineligible withdrawal subjects you to a 10% penalty on the ineligible amount, with additional income tax placed on it. The requirements for a qualified withdrawal are inconsistent across the country. For example, though the Tax Cuts and Jobs Act allows for qualified withdrawals for K-12 education, this does not apply in every state. Failure to research and make informed decisions can result in hefty penalties.
You might also incur penalties if your child doesn’t go to college. As the asset owner, you can change beneficiaries, but your alternative options might not be attractive.
3. Not All 529 Plans are Good
Not all 529 plans are created equal. Though they generally have great benefits, things like cost, contribution limit, and deductibility can vary. For some, these can be dealbreakers. Our advice? Do some research. At the end of the day, only you can decide which option is best for you.
4. Not All States Offer Tax Deductibility
Expanding upon our last point, 529 plans can vary widely by state, and within states. A major point of variation is tax deductibility. Some states like Ohio, Maryland, and Virginia offer a tax deduction for your contributions. States like California, however, do not. If your state doesn’t offer tax deductibility, don’t count yourself out. One advantage of 529 plans is their portability.
5. Investment Options
Another crucial variable when choosing your child’s savings plan is investment options. Research your plan before making a decision, and explore your options thoroughly and carefully. Look for broad-based rather than limited investment options. With so many 529s offering large contribution limits, you don’t want to get stuck with a limit on saving for your child’s future. Pay attention to the costs of these investments- the point of the plan is to save money, not spend it all in the process.
Closing Thoughts
For many parents and grandparents, the 529 plan is a great way to save money for your child’s education, and receive benefits for doing so. It might be a great plan for you, too- but with your child’s academic future at stake, you don’t want to jump into an important decision without research. Today we explored some downsides of the 529 plan. While the 529 plan comes with its disadvantages, we encourage you to research before counting them out. Penalties, for example, can be avoided due to the flexibility of 529s. FAFSA can aid families, but a backup plan such as a 529 can be invaluable. We created these lists as guides, but each unique situation requires its own research and individual counseling.
Now that you’ve weighed the pros and cons of this investment plan, factoring in the eligible expenses, what do you think? Are you considering the 529 plan? If not, what other options are you exploring? Tell us your thoughts, and more topics you’d like to see us discuss, below.
Looking for an independent fiduciary financial advisor who can advise you on investments, retirement, real estate, alternative assets, and taxes? Contact ACap Advisors & Accountants to schedule a free initial consultation. Our clients include individuals, small businesses, entrepreneurs, and anyone serious about saving and investing for their future.
