What to think about before signing up for a 529 plan?
Before signing up for a 529 plan – a tax-advantaged education savings account – there are several important considerations to keep in mind:
Education goals: Determine your education goals for yourself or your beneficiary. Consider factors such as the type of education (undergraduate, graduate, vocational), estimated costs, and the timeframe for when the funds will be needed.
Investment options: Evaluate the investment options available within the 529 plan. Different plans offer different investment choices, such as mutual funds, age-based portfolios, or target-enrollment portfolios. Consider your risk tolerance, investment preferences, and the historical performance of the available options.
Fees and expenses: Understand the fees and expenses associated with the 529 plan. These may include administrative fees, investment management fees, and underlying fund expenses. Compare the costs across different plans to ensure they are reasonable and will not significantly erode your savings.
Tax implications: Familiarize yourself with the tax benefits and consequences of the 529 plan. Contributions to a 529 plan are typically made with post-tax dollars, but some states offer tax deductions or credits for contributions. Withdrawals made for qualified education expenses will be tax-free.
Flexibility and portability: Consider the flexibility and portability of the 529 plan. Prepaid 529 plans restrict the use of funds to specific educational institutions or expenses, while 529 savings plans can be used at any institution that qualifies for federal financial aid. If you’re not sure where your child will go to college, a savings plan is the safer choice.
Financial aid considerations: Understand how the 529 plan may impact your child’s financial aid eligibility. 529 plan assets are considered parental assets for federal financial aid purposes, which means they will have a minimal impact on your family’s Expected Family Contribution (EFC).
Plan management and reputation: Research the plan provider and their reputation for customer service, investment performance, and overall management. Look for reviews and ratings from reputable sources like Backer to ensure you choose a plan with a solid track record.
Withdrawal restrictions: Review the rules regarding withdrawals from the 529 plan. Withdrawals from a 529 plan for non-qualified expenses are subject to a 10% penalty and tax on the growth of the investment (not the principal you put in). This is important to understand before you decide to use a 529 plan to save for your child’s future education expenses.
Estate planning implications: If you are concerned about estate planning, consider how the 529 plan fits into your overall estate plan. Contributions to a 529 plan can potentially reduce your taxable estate, as gift tax rules allow you to give up to $17,000 per year (or $85,000 for five years at once, which is called “superfunding” the account) without contributing to your maximum lifetime gift tax exclusion ($12.92 million as of 2023).
Eligibility and residency requirements: Review the eligibility criteria for the 529 plan you are considering. Some plans have residency requirements, meaning you may need to be a resident of a particular state to open an account. Ensure you meet the necessary requirements to participate in the plan.