When it comes to saving for your child’s education, you’ve got a number of options. But only one type of plan allows parents to make tax-free withdrawals for qualified expenses1 and maintain control of the account: 529 college savings plans. Although they’ve been around for more than 20 years, many parents still don’t understand a lot about them. Here are some of the more common myths about 529 plans.
Myth 1: A 529 plan can only be used to save for an in-state school.
Actually, 529 college savings plans can be used at any accredited institution that is eligible to participate in U.S. Department of Education financial aid programs. This includes public and private 2- and 4-year colleges and universities, graduate schools, and trade/vocational schools. Currently, there are more than 6,500 eligible institutions.2 529 accounts can also be used to pay for tuition for children in kindergarten through grade 12, up to $10,000 per school year.
Myth 2: You’re better off sticking with your local state plan.
You can invest in almost any state’s 529 plan regardless of where you live; however, 34 states and the District of Columbia currently offer a full or partial state tax deduction or credit on contributions.3 Even if your state does offer a tax benefit, it’s still a good idea to check out other options, as 529 plans vary widely. Among the things you should look for when evaluating 529 plans:
- The range of investment options available
- The account and investment management fees the plan charges
- The types of automatic contribution and rebalancing features offered
- The maximum plan limits allowable by state
Myth 3: High-income earners can’t contribute to a 529.
There are no income limitations to a 529 college savings plan, making them great vehicles for gifting and estate planning purposes. While they do have maximum aggregate limits, they’re generous, ranging from $235,000 to $529,000, per child, determined by state. The IRS allows individuals to make an annual gift of $15,000 per recipient ($30,000 for couples filing jointly) without triggering taxes. It also allows individuals to gift $75,000 ($150,000 for couples) in a single year if those gifts are averaged out over five years of tax filings.1
Myth 4: Savings in a 529 plan dramatically reduce financial aid eligibility.
529 college savings plans do affect financial aid, but not to the degree you might think. When determining your child’s Expected Family Contribution (EFC), which is the formula used to gauge financial aid, the percentage of parents’ assets that will be used to pay for college expenses is capped at 5.64%. For the child’s assets, the amount assessed is 20.0%.4
Myth 5: 529 accounts are difficult to open and maintain.
It’s simple to open and fund a 529 account. But before you do, be sure to talk to your financial professional. He or she can help you decide which plan may be the best fit for your family. Your financial professional can also help you manage the investment options, determine how much to invest, and oversee the distribution phase when the time comes.
1 For 2019. State laws and treatment may vary. Earnings on nonqualified distributions will be subjected to a 10% federal penalty tax. Please speak with your tax advisor for more information.
2 2019–2020 Federal School Code List, U.S. Department of Education, February 2019.
3 "State Tax Deductions for 529 Contributions," FinAid.org.