A Closer Look At Saving For Education Using A 529 Plan


Being that is it National 529 Day, we thought it would be appropriate to take a closer look a saving for education through a 529 plan.  However, we will also compare a few other options that may make sense for you depending on your specific situation.

What is a 529 Plan?

A 529 plan is generally a qualified tuition program created by the government in the 90’s to incentivize saving for educational goals.  The “529” comes from the location of the rules governing the program in section 529 of the Internal Revenue Code.

There are actually two types of 529 plans: prepaid tuition plans and savings plans.  The later is the most popular as the prepaid plans allow you to pre-pay tuition at today’s prices, typically reserved for participating in-state public universities.  Savings plans are much less restrictive, and therefore more popular than prepaid plans.

While the plans are governed by the IRS, they are created by individual states to allow for states to tailor them to their needs, specific to their university system.  Most states offer at least one plan.  In some states, there are multiple plans available.  However, you can use any plan regardless of which state it is from.  Be sure to check with your state’s plan for potential tax deductions on contributions or for tax-free earnings on qualified withdrawals.  If you don’t have a specific state tax benefit, there could be a better option with another state’s plan.

Investment Options

Every 529 plan will have a different lineup of investment options that you can use with varying levels of costs and features.  You’ll want to make sure you choose a plan that has investment options that match your risk tolerance and goals.  Most plans offer age-based investment options that adjust as your child gets older and closer to using funds.  This is helpful as you want to make sure the aggressiveness of the portfolio matches the time horizon of the goal.  These model portfolios are ideal given that there is a limit of two changes to investment elections per year in 529 plans.

Fees & Expenses

The difference in fees and expenses can drastically separate some plans.  Some may offer only one option while others may offer several share classes of investments.  You’ll want to consult with your financial advisor to determine which is best for you, based on your goals.  Advisors are compensated differently, depending on the plan, so be sure to ask your advisor how they are compensated.  Some state’s plans are not available for use by financial advisors.  Ask your financial advisor about the differences between advisor-sold plans and non-advisor sold plans.  You may prefer to pay a commission to your advisor through the investment options, or you may prefer to find a plan that is fee-only, where your advisor charges you a flat fee either one time or annually to give you advice on investment options and/or assist with processing contributions/withdrawals.  If you are confident that you can make those decisions and want to handle the operational portion of it, then a non-advisor sold plan might be best for you.

Whether you choose a plan through an advisor or not, choosing a reputable financial institution with a track record of good customer service is important.  It’s also important to consider ease of use.  Is their website easy to navigate?  Can you process contributions and withdrawals online?  Can you make address changes, automatic investment changes, or add a bank account online?  Do you want to do all those things yourself or have an advisor to do it for you? As a reminder, whether you end up using one or not, it’s important to consult with a financial advisor when making these decisions.

Qualified Withdrawals

One of the most important aspects to understand about 529’s is what expenses are qualified, meaning you don’t pay taxes on the growth of the funds when you make a withdrawal.  That is the primary driver, as to why people choose to use a 529 versus other savings vehicles, but it can add some complexity as you have to keep track of expenses and make sure you match withdrawals with qualified expenses.

These qualified expenses have always included the full cost of tuition, fees, books, equipment, and room and board of accredited colleges or universities in the United States.  More recently, the plans were expanded to allow $10,000 per year to be used for K-12 expenses and a $10,000 lifetime limit per beneficiary for student loan repayment.  You can also move funds to pay off up to $10,000 of student loans for the beneficiary’s siblings.  There is an existing plan called a Coverdell ESA which was designed to save for K-12 expenses, but these are basically obsolete with the expansion of 529’s to include K-12 expenses.


One of the benefits of 529’s is that anyone can contribute to them.  Whether it’s the parents, grandparents, friends, or even the beneficiary themselves.  This flexibility means you don’t have to open separate accounts for each contributor, and all the funds can be held for each beneficiary.  However, siblings do need to have separate accounts.  You can always move funds for a 529 to the account of a member of the family without penalty.  There are specific rules that we won’t delve into here, but these transfers can be to parents, in-laws, and even first cousins.

Grandparents & FAFSA

If the students are planning to fill out the FAFSA (Free Application for Federal Student Aid), it would be best to open 529’s in the grandparents’ name to avoid those assets being included on the FAFSA.  Students’ and parents’ assets are included, but grandparents are not.  This is a popular planning strategy for wealthy grandparents trying to efficiently draw down their estate with the least taxes or penalties.  There are other factors to consider with that strategy, so it is best to consult with a financial advisor to help determine the best course of action for your specific situation.  Also, keeping in mind the estate and tax ramifications if the grandparents pass away still owning the assets.  If keeping the assets out of the parents’ name seems attractive, be sure to consult with a financial advisor and/or estate planning attorney to understand what else might need to be done.

Should you use a 529?

After walking through the specifics of what a 529 is, and the rules and limitations that exist, many ask if all the headache is worth it?  The greatest benefit you can get from a 529 is the compounding time value of money.  Given that the goal starts out at birth, usually as an 18-22 year funding goal, that time horizon begins shrinking immediately.  As that happens the ability for the funds to grow substantially starts shrinking as well.  Even if you start at birth, a typical age-based portfolio will be predominantly fixed income 10 years before the end of the spending goal for a child that starts college on time and earns a four-year degree.

If you start saving at birth, the tax savings and the time value of money are compelling reasons to use a 529 if you a certain your child will end up going to a four-year university.  If that isn’t a certainty in your mind, or you are getting a late start to saving there might be some other alternatives that I alluded to earlier.

Custodial Account Option (UTMA \ UGMA)

If you trust your child or think you will be able to trust them when they reach adulthood, a custodial account may be a great option.  The funds in the account are deemed irrevocable gifts to the child but can be used for their benefit before they can take control at 18 or 21 (depending on the state), including to pay for college.  Earnings are taxed at your child’s tax rate, subject to kiddie tax rules, but for the most part, the taxes are virtually zero throughout their time as a minor if managed properly.  If you are seriously considering this option, it would be best to consult your tax advisor to see if the kiddie tax rules would apply, etc.

Roth IRA’s?

While technically not an account that is typically used for college savings, if you can contribute to a Roth IRA you might want to consider this option.  The contributions you make to a Roth IRA can always be taken out free of taxes.  The earnings, while they would be subject to income tax, are spared the tax penalty if used for education.  It may not be the best option out there, but if you want to use a few different options for funding the goal, this should be considered.

Last resort

If you aren’t sure your child will go to college, aren’t willing to trust them with your hard-earned money when they reach adulthood, and aren’t eligible to contribute to a Roth IRA, maybe a simple savings or taxable investment account would be best.  The one point I want to get across is that no matter what type of account you choose, the most important decision you can make is to save for your goals.

As I have said many times, should you have questions as to how this applies to you, please consult with the appropriate advisor whether it be related to taxes, investments, or legal concerns.

Engage with the entire Blakely Financial team at WWW.BLAKELYFINANCIAL.COM to see what other expert advice we can provide towards your financial well-being.

WILL ARMFIELD is a financial advisor with BLAKELY FINANCIAL, INC. located at 1022 Hutton Ln., Suite 109, High Point, NC 27262, and can be reached at (336) 885-2530.

Blakely Financial, Inc. is an independent financial planning and investment management firm that provides clarity, insight, and guidance to help our clients attain their financial goals.

Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Adviser.