2 Pros and Cons to Saving for College in a 529 Plan
KEY POINTS
- With a 529 plan, you can enjoy tax-free investment growth on the money you're saving for college and designate a new beneficiary as needed.
- On the flipside, you'll face penalties if you don't end up using your money for educational expenses.
Paying for college is no easy feat these days. The average cost of tuition and fees at private college was $39,723 during the 2022–2023 academic year, according to U.S. News and World Report. Granted, there are less expensive options than private college. But even state schools have gotten expensive.
The average cost of tuition and fees at public out-of-state schools was $22,953 for the 2022–2023 academic year, and $10,423 at public in-state schools. This means that a student looking to attend college in their state of residence is facing costs of almost $42,000 all-in before even factoring in expenses like books and supplies (and assuming the aforementioned figure holds steady).
If these numbers are inspiring you to start saving for college before your kids are old enough to walk, you're not alone. And that's actually a really smart move. The earlier you start saving and investing for college, the more opportunity your money will have to grow.
Now, when it comes to saving for college, you have options. You could put your money into a brokerage account, and that way, you'll have no restrictions. But you may want to consider saving for college in a 529 plan instead. Here are some pros and cons of going this route.
Pro No. 1: Tax-free gains
When you invest in a regular brokerage account and make money, you're liable for capital gains taxes. With a 529 plan, you can get out of paying those taxes the same way you can in a Roth IRA, as long as that money is used for qualifying education expenses.
So let's say you put $40,000 into a 529 plan over the course of several years, and that $40,000 grows into $70,000 over time. If you use all of your money to cover college expenses, you won't be taxed on your $30,000 in gains. That's a lot of savings.
Pro No. 2: Flexibility to change beneficiaries
You might fund a 529 plan to put your kids through college. But if they decide not to go to college, or if you wind up with more money in savings than what you need, you're not out of luck. You can easily designate a new beneficiary for your 529 plan, whether it's a grandchild or even yourself, should you decide to go back to school.
Con No. 1: There are penalties for non-qualified withdrawals
We just learned that 529 plans give you tax-free growth on your money if it's used for qualifying education expenses. But if you take a non-education withdrawal, you'll be assessed a 10% penalty on the gains portion of your withdrawal. You'll also be taxed on your gains.
Con No. 2: There's no tax break on contributions
When you put money into a traditional IRA or 401(k) plan for retirement, your money goes in tax-free. But 529 plans don't work that way. The tax break comes on the gains portion of your account, but that may not make it any easier for you to carve out money to put into a 529 in the first place.
All told, a 529 plan could be a great home for your college savings. But you may want to spread out your savings between a 529 plan and other options. That way, not only do you get some tax benefits, but you also get more flexibility with your money.
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