- A 529 account is an investment tool used to save for educational expenses.
- It's commonly used to save for college but can be used for other types of education as well.
One of the biggest misconceptions that Sabino Vargas, a certified financial planner, hears about saving for college is that it's something only rich parents do.
"The truth is that about half of all American families are currently saving for college," said Vargas, a senior advisor with Vanguard Personal Advisor Services. "It's never too late to start, and you can usually start with a small amount."
Whether you're saving for college or aren't sure whether your children will pursue higher education, a 529 can be an important tool. Unfortunately, there are a lot of misconceptions and misunderstandings about these accounts, including who can benefit from them, said Alicia Sanchez, a financial blogger at Mamas Dinero.
"Knowledge is power, so let's dig into what makes kids' 529 accounts so glorious," Sanchez said.
529s aren't just for college
These accounts were initially designed to help save for the high cost of college. But now 529s can be used for lots of other things.
"These include tuition for college, grad schools, and trade schools; books and supplies; technology costs, and others," Vargas said.
Some states let you use 529 funds to pay for K-12 education expenses, like private-school tuition. More recently, legislation passed that allows people to use $10,000 in 529 funds to repay student loans. And beginning next year, people will be able to convert 529 savings to a Roth IRA, a type of retirement account.
There's a misunderstanding that you'll lose the money in a 529 if your child doesn't go to college, but "the truth is that 529 plans are quite flexible," Vargas said.
Having a 529 gives you tax benefits
Unlike retirement accounts, which you pay into before paying taxes, the money that you contribute to a 529 plan has already been taxed. Once it's in the 529 account, the money is invested and grows tax deferred, meaning you won't pay income tax on the gains. If you use the money for qualified education expenses, you won't pay federal tax on it. In addition, some states let you deduct some or all of your contributions.
"The tax breaks alone are a great reason to consider 529 plans," Vargas said.
They won't have a huge impact on financial aid
Lots of parents worry that if they save for college, their children will qualify for less financial aid. But that's usually not the case with 529s. That's because 529s are considered the property of the person who established the account — usually parents, but also grandparents or friends.
Since they're not the property of the beneficiary — the person whose expenses are covered — they're less likely to affect financial-aid decisions.
"If you are the parent and owner of a 529 plan for your child, the impact on financial aid is quite low," Vargas said.
Still, this is an important point to discuss with your financial advisor, since 529s "can still affect eligibility in some cases," Sanchez said.
The accounts are transferable
Say you start a 529 account for your oldest, but they decide not to pursue higher education or they go to a low-cost vocational school. The money left in the 529 account can be transferred to a different beneficiary.
"They can save for anyone," Vargas said. "Their child, grandchild, another family member, and even themselves."
You can still access the money if you need to
Lots of people worry that once they put their money into a 529 account, it's locked away. But it's possible to access the funds if you need them in case of an emergency or a change in your financial situation.
"The account owner maintains control of the funds and can withdraw the funds at any time," Sanchez said. If you're not using the money for education-related expenses, you'll have to pay taxes and fees. Still, withdrawing for nonqualified expenses is an important option for people to be aware of.
How to choose a 529
Before you open a 529 account, consider these things, said Sanchez:
- State tax benefits: Since these vary by state, it's important to look into specific laws where you live or work to see how a 529 can impact your state taxes.
- Fees and costs: Look at any fees you'll be charged regularly and what the cost will be if you need to withdraw funds for nonqualified expenses.
- Investment choices available: Ask about where your money is being invested and what type of risks that entails.
- Initial investment amounts: Some accounts require a minimum to open an account. Remember that with compound interest, even a small amount can grow significantly over time.