Here’s Why I Only Keep a Portion of My Kids’ College Savings in a 529 Plan

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This writer uses 529 plans sparingly. Read on to see why. 

Like many parents, I find the idea of paying for college daunting. For the 2022-2023 academic year, the average cost of tuition and fees at private colleges was a whopping $39,723, according to U.S. News & World Report. That’s almost $160,000 for a four-year degree, and it doesn’t even include room and board.

Of course, there are options outside of private college. But even in-state schools aren’t such a bargain anymore.

For the previous academic year, the average cost of tuition and fees was $22,953 for out-of-state students at public colleges and $10,423 for in-state residents at public schools. So even the “cheapest” option of the bunch doesn’t look so cheap to me.

It’s for this reason that I’ve been saving for college since my kids were born. And I made a point to open a 529 plan for each of them at a young age.

But I actually keep the majority of my kids’ college savings in a regular brokerage account, not a 529 plan. Here’s why.

It’s all about having options

My oldest child is a good seven years away from college, and I have no idea what the costs are going to look like at the time. And I fear that they’ll continue to rise.

But I also have no idea what colleges my kids will want to attend, or if they’ll even want to attend. And that’s why I refuse to put more than a small portion of their college savings into a 529.

The upside of a 529 plan is that you get to enjoy tax-free gains on your investments. With a regular brokerage account, gains are taxed year after year.

But if you take a withdrawal from a 529 plan for non-education purposes, you’ll get penalized 10% on the gains portion of your account. You won’t get penalized on your principal contributions because they go in on an after-tax basis.

But even so, if you save and invest well for college over many years, it’s conceivable that you could end up with $200,000 in gains in a 529 plan. So facing a 10% penalty on that sum means losing $20,000.

That’s why I’d rather keep most of my kids’ college savings in a regular brokerage account and forgo the tax savings. That way, if my kids opt out of college, they can use that money to start a business or whatever else they might need it for. (Or hey, I could even decide that I’m taking it back and using it for my own retirement.)

Be careful with 529 plans

The idea of tax-free gains is appealing, and that’s what makes 529 plans a good college savings choice to a degree. But I’d caution anyone in the process of saving for college against overfunding these plans. You don’t want to get stuck in a situation where you’re looking at penalties because your college costs are less than expected and you now have extra money to deal with.

That said, a recent change to 529 plan rules allows you to roll up to $35,000 per beneficiary into a Roth IRA. This limits your risk to a nice degree, and it’s a very positive update. But it still pays to be careful with the amount of money you put into a 529 plan.

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