9 Mistakes Not to Make With 529 Savings Plans

Allison Kade

You want the best education for your child, but college costs have increased tremendously over the past decade.

According to stats from The College Board, between the 2002–03 academic year and the 2012–13 academic year, tuition and fees at private nonprofit four-year colleges rose by an average of 2.4% per year. Over the past decade, the inflation rate for public four-year colleges was also high at 5.2%.

Today, the average cost for just one year at a private nonprofit college—that includes tuition and fees, as well as room and board–comes in at $39,518. At a public university, it’s $17,860—and that’s paying in-state tuition!

One of the best ways to save for these mind-boggling costs is to open a 529 savings plan, which is a state-sponsored, tax-advantaged account. With any 529 savings plan, the money that you invest will grow without being subject to federal income tax. And you’ll also avoid paying federal income taxes on any money that you take out of the plan—as long as you use it to pay for qualified educational expenses, such as room and board, tuition and books.

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A total of 34 states, as well as the District of Columbia, offer a state income-tax deduction or credit for residents who contribute to their state’s 529 savings plan. Five states—Arizona, Kansas, Maine, Missouri and Pennsylvania—provide a state income-tax break if you contribute to any state’s 529 plan. (For more information, savingforcollege.com has free tools that allow you to compare various 529s.)

But before you rush to invest in one of these plans, there are some pitfalls that should be on your radar—like these top nine blunders that well-meaning parents tend to make.

1. Forgetting About the Fees

Like mutual funds, most 529 savings plans charge a percentage of your investment to cover operating costs. The plans fall into two basic categories—those sold directly by the states and those sold through investment advisers, the latter of which tend to be more expensive.

According to the Financial Research Corporation, a typical 529 plan offered through a state has an average annual fee of 0.69%, whereas a 529 sold through a broker has an average annual fee of 1.17%. Although the difference may seem negligible at first, it adds up. If you invested $10,000 over 18 years (assuming you’d get a 6% return), you could have $2,000 less in a 529 plan with a 1.17% fee, compared to a plan that charges 0.69%.

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2. Investing in a Prepaid 529 Without Reading the Fine Print

529 savings plans aren’t the only type of 529 out there. Some states also offer 529 prepaid tuition plans that allow you contribute money today in order to lock in prices at a state university years from now. You generally pay a premium over current tuition prices to account for inflation, but considering the rate of tuition growth in recent years, paying in advance often still sounds preferable.

But there’s a catch.

  • EF

    If you save more than your child ends up needing for his/her education, are you penalized by heavy taxes when you withdraw the remaining money? For example, if I save up for private school and my son goes to a state school we’ll have a lot of money left and potential no further education to use it on. What then?

    • KM

      If what I’ve gathered is correct, I am by no means a finance expert. If you withdraw it for non-educational use, then yes, you would have to pay taxes. But you can change the beneficiary. Transfer it to yourself and go back and study that subject you really wanted to learn about. Or transfer it to a needy cousin or other relative. Or hang onto it, perhaps your son will decide he doesn’t like his chosen career in a few years and want to go back to school for something else. You could probably even keep it around for a future grandchild’s education.

  • 305305305

    Parents needs to start saving as early as possible…..Check out GradSave, it is a way for parents to save for their child’s college education using a “Fee-Free” crowd-funding platform. Parents build a community of friends and family who contribute to a child’s 529 college savings plan and receive the extra support needed to reach their savings goals.