First, what is a 529 plan and what are it’s benefits!
What is a 529 plan?
These are college saving plans that are operated by state or educational entities. The “529” numeric element refers to the IRS code with created these types of plan in 1996. There are typically 2 types of plans:
Prepaid Tuition – You buy credits at today’s prices for future use! The logic is that it will be cheaper to buy it today at the current prices rather than in the future after cost have skyrocketed (and historically this has typically been the case).
Savings – Typically you put money in investments such as mutual funds, bond funds, fixed income, etc. These vary vastly with respect to what is offered…
What are the Benefits?
- Distributions from these plans used for qualified educations expenses are exempt from federal income tax.
- Contributions to a 529 grow tax free while in the plan.
- With some states (including mine), the contributions to state 529s are deductible from state income taxes. This varies in detail from state to state!
- As long as the student is a half-time student, the distributions are tax free when used for room and board.
*For an excellent Wiki at Wikipedia click here!
My Personal Experience:
When I started the 529 for my son, the market was very high because of the tech bubble, so I lost money the first few years. To make matters worse, I went with an Age based mutual funds in my plan. I didn’t lose money but each year they rebalanced the portfolio for me, putting more in bonds and fixed income as my son aged. So it’s been just a fair investment for my son.
My daughter has done considerable better, at least until this last downturn. Her balance (since it’s has a higher proportion in equities) lost more money than my sons, but she’s coming back too.
So, in a nutshell, I’ve done okay with the plans, but not as well as I hoped. Such is life though, I still think it’s worth have them, after all, the important point is to be prepared for the high college cost in the future (which should be substantial, private college may be higher that $200,000)…
If you child decided not to go to college, then the 529 earnings is tax and a 10% penalty will be applied (you might even have to replay the deductions from your state income tax back too)…
So reader, how are you preparing for high future college costs?
-MR
We’re going to start a 529 savings plan as soon as our son is born (3 weeks, yikes!). Based on your experience, do you recommend staying away from age-based mutual funds?
@Mrs. Frugal
For me it didn’t work out so well, because when the rebalancing occurred, the market was at the bottom, so when the equities in the fund recovered, I didn’t get that extra juice. So for me, no it wasn’t the best option.
That said the theory behind the age based fund is very sweet! It automates the process for you, which is beautiful!
So, I’m thinking about doing both. I’m going to take, oh maybe 25% of my holdings and pick a good mutual fund (probably a value instead of growth fund) that I think will do well, but that’s not too agressive!!! 75% I will leave in the Age based funds that I have. I probably change my future contributions so that they are evenly split between the Age and Value mutual funds. If you have ETFs in your 529, I’d go for that if I were you. At least if it’s comparable to the mutual fund you are thinking of investing in!
The most important thing is that you are thinking and starting now!!! Kudos to you 🙂
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When we were completely ignorant we started a coverdell for our kids. Then when we were less ignorant we began a 529 (index funds). We continue to fund them but I question if it is the best decision.
I lean towards making our kids figure out how to cover (mostly) their college expense. At the current rate we are hopeful for scholarships.
If it all comes together then we get hit with a penalty for taking responsible action that was unnecessary. That bothers me.
@LeanLifeCoach
I think I read something about if you get a scholarship, the penalty or taxes get waived. I’ll have to read it again and do and update on the page, or do a new post…
At least if you do get a scholarship, you only get taxes and penalties on the earnings of the accounts, and not the contributions to it that you made. I didn’t know that at first, but it makes sense.
As a side note, if your child does not go to college or gets a full ride, most plans (I believe) allow you to ‘transfer’ or change beneficiaries for that 529 plan. So, if oldest son gets a full ride but you have 50k put away in his 529, you can transfer that money to one of your other kids, penalty free. (or nephew, etc).
Personally, I have liked how to age-based balancing has worked out for us. Like the market in general, it probably will not time out perfect for you. But as my son is getting close to college, I feel better having the money in safer investments. I started saving for his college when he was born, and I would have gone mostly with stock had I been investing for him on my own. Then I probably would have gone more conservative as he aged too. But instead, the 529 did it for me and I didn’t have to deal with the hassle.
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