529 college savings plan are to college savings what Roth IRAs are to retirement savings. You make after-tax contributions and qualified distributions in the future come out entirely tax free. All in all, it’s a great deal.
As great as these accounts are, however, there are a lot of misconceptions out there about exactly how they work. Earlier this week, I was catching up on some podcasts when I ran across one from Vanguard covering five such myths.
Here they are, along with a healthy dose of the truth about each one:
- Myth #1: 529 accounts are difficult to open and maintain. In reality, accounts can be opened online in just a few minutes. You’ll need the beneficiary’s birth date and SSN but, aside from that, it’s very easy. Also, because most plans offer age-based allocations, there’s no need to manage the investments on a daily basis.
- Myth #2: You can only use 529 assets for schools in the state that sponsors the plan. While 529 are all sponsored by individual states, you can use proceeds from them to cover eligible expenses at most 4 year colleges and universities, as many two years schools and technical colleges. The primary exception to this are pre-paid tuition plans, which are typically tied to a particular state.
- Myth #3: If your child doesn’t go to college, you’ll lose your assets. If the beneficiary doesn’t go to college, or if there is money left over when they’re done, you have two options. First, you can transfer the account another beneficiary (including yourself), or withdraw and pay taxes plus a 10% penalty. This latter option isn’t great, but it’s far better than losing your account balance.
- Myth #4: 529 investments dramatically reduce financial aid eligibility. While it’s true that parent-owned account are included in financial aid calculations, less than 6% of the money in these accounts is counted when filling out the FAFSA. The situation is even better for grandparent-owned accounts, which have no effect whatsoever on financial aid calculations.
- Myth #5: Only account owners can contribute to a 529 plan. While 529 college savings accounts can only have a single owner, anyone (family, friends, etc.) can contribute to the account on behalf of the beneficiary.
If you’re currently in the market for a 529 college savings plan, you might also be interested in the following articles from the archives:
- The Best 529 Plans â€“ 2009 Edition
- The Worst 529 Plans â€“ 2009 Edition
- The Best 529 Plans, Revisited
- The Three Best 529 Plans
Do you have a 529 account? If so, which one? And what do you like/dislike about it?
6 Responses to “Five Common 529 College Savings Plan Myths”
@Doug – I’m not sure I worded my question properly. What I mean is, say hypothetically that Junior is going to college next year and I’ve saved enough to cover all four years of tuition/expenses at State U – $100K. Junior just found out that he’s going to get a $10K scholarship each year – thus I’ve oversaved by $40K. I’ve been told that the $40K would not be subject to the 10% non-qualified withdrawal penalty. This makes sense logically, because we shouldn’t be penalizing people for getting scholarships. But is that really the case?
I am not a 529 expert but, as a college administrator, I can tell you that we receive 529 disbursements all day long and from what I can tell as long as the funds are disbursed directly to a college, you won’t have any problems with the penalty.
We have a 529 for our son. We set it up right after he was born, and it’s been great – his dad and one grandpa make regular payroll autodeductions into it, and other people can easily choose to give him cash gifts instead of toys, which is helpful on both sides – he gets the money, we don’t have more junk at home.
We went with the one in our state because it was easiest for us – once it’s set up, all people need to make the deposits is the account number. It has an asset allocation by age option that has moderate (not super-low) fees.
The only problem we’re coming up against is, he’s 5 years old and has more than $10K in the 529 – my partner and I disagree at what point we should stop putting money in. I figure, if we drastically overfund it, when he starts college I’ll go ahead and go to grad school for fun. But he also has cousins with no college savings at all and it would be nice to be able to give them a little, if we have too much.
I’ve heard that if your child obtains a scholarship, you can withdraw that amount from the 529 plan without paying the 10% penalty – is that true?
Good stuff. I’ve been worried about the eligibility situation you mentioned for Federal Aid.
I’ve got a 529 opened in Ohio. I’ve been pleased so far — not many investment options, but does include some Vanguard funds which makes me happy. I’m savings for my wife’s graduate school, or our future children’s college. Not sure which route we’ll take…