Personal Finance

What to Know About 529 Plans

September 14, 2017
The most common misconceptions regarding 529 plans and the reality of each.

Key Points

  • Only 27% of parents who are saving for college are using a 529 plan, according to T. Rowe Price’s recent Family Financial Trade-Offs Survey.
  • The misconceptions about 529 plans include concerns with accessing and using the money.
  • The reality is that 529 plans offer significant flexibility and tax benefits to help you save for your child’s college education.

Almost half of parents saving for college (48%) are using a regular savings account, while only 27% are investing in a 529 plan, T. Rowe Price’s recent Family Financial Trade-Offs Survey revealed.

"Lack of awareness seems to be the primary reason for low enrollment," says Paul Bishop, CFP®, a financial planner with T. Rowe Price. "And those who have heard of a 529 plan often think it's too good to be true or that there may be some kind of catch."

Misconception #1:

A 529 plan won’t allow me to access my money if I need it, and if I don’t use it, I’ll lose it.

Our survey found that one in every four parents who is saving for college, but not using a 529 account, is concerned about having access to their money. In addition, almost half of parents think that if the money in the account is not used for college, it’s lost.

Reality:

A 529 plan offers significant flexibility, and you can access the money at any time, for any reason. The money is always yours and stays in the account until you withdraw it. You don’t ever forfeit it. If the beneficiary listed on the account doesn’t go to college or, for any reason, doesn’t use all of the money, you can change the beneficiary on the account to a relative of the beneficiary, such as a sibling, a cousin, or possibly even yourself, and use the money for their college education expenses—without any penalty. The money also can be used for higher education expenses other than undergraduate tuition, such as room and board, graduate school tuition, books, and supplies.

If you do need to withdraw funds for anything other than a qualified educational expense, you’ll need to pay income taxes on those earnings, as well as a 10% penalty on the earnings. But what’s important to remember is that your contribution portion is never taxed or penalized.

For example, let’s say you contributed $5,000 to your child’s 529 plan and it earned $2,000, giving the account a balance of $7,000. If you withdraw all $7,000, only the $2,000 in earnings would be subject to taxation and the 10% penalty. (Remember: The earnings haven’t been taxed while they were in the account.) If you are in the 25% tax bracket, this would mean paying 25% as well as 10% of the $2,000 in taxes and penalties ($700)—leaving you with $6,300 to spend.

Misconception #2:

I can only use my state’s 529 plan, and if I do, my child can only attend a state school.

Reality:

The money saved in a 529 account can be used at almost any private or public college, university, graduate school, vocational school, or trade school anywhere in the country, not just the state you live in or the state sponsoring the plan in which you invest. Some international schools qualify as well. Of course, the specific plan may have residency requirements, but, generally, you can invest in any 529 plan and use your savings just about anywhere.

Misconception #3:

Saving in a 529 plan is no different than using a Traditional or Roth IRA or a regular savings account.

Reality:

A 529 plan is the only account that gives you tax-free earning potential for educational expenses. The account is tax-deferred, meaning you don’t pay any taxes while invested, and any earnings are tax-free when used for qualified educational expenses. In comparison, there are no tax advantages to investing in a savings account and, for the most part, if you use an individual retirement account (IRA) for college expenses, your earnings would be taxed, and, in some scenarios, a penalty would be applied. All other things being equal, the 529 account generally enables more of the account proceeds to be used toward higher education expenses instead of being lost to taxes and penalties. Additionally, many states offer tax benefits for contributions to a 529 plan. That’s just another added bonus.  

A 529 plan offers significant flexibility and tax benefits to help save for a child’s college education. To figure out how much you should be saving, check out our online College Savings Planner. The most important thing is to save something and to start earlier rather than later. "Every dollar saved is one that does not have to be borrowed, which can help in not burdening a child with student loan debt upon graduation," says Bishop.

529 Plans Managed by T. Rowe Price

With T. Rowe Price, it’s easy to start saving for college, technical school, or graduate school. We manage three flexible and tax-advantaged 529 plans:

All three plans are designed with nearly every budget, situation, and aspiration in mind.

Please note that a 529 plan’s disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. You should compare these plans with any 529 college savings plans offered by your home state or your beneficiary’s home state. Before investing, consider any tax or other state benefits, such as financial aid, scholarship funds, and protection from creditors that are only available for investments in the home state’s plan.

View investment professional background on FINRA's BrokerCheck.

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