Is a 529 College Savings Plan Right for My Family?

Are 529 plans the right choice for all families saving to send their kids to college? While a great college-savings tool, 529 plans are not necessarily right for every household.

Generally 529 plans are advantageous under the following conditions:

  • The plan is established for a very young beneficiary. This allows the chief benefit of 529 plans – namely, tax-free compounded growth – to provide a true advantage over other taxable forms of funding.
  • There is more than one child in the family. The tax-free benefits not used for qualified college expenses by a 529 beneficiary can be transferred to a sibling.
  • The plan is owned by a grandparent or non-parental relative. In this case, the assets in the 529 have no impact on the student’s eligibility for financial aid. However, even when a parent owns the 529, the impact is minimal as a result of 2005 changes in financial-aid rules. Only 5.6 percent of the 529 plan assets are now assumed eligible for college costs, as opposed to 20 percent for custodial plans. Because of this differential, many parents transfer existing Uniform Transfer to Minors Act (UTMA) or trust accounts into 529s.
  • The plan is established in a state that offers residents a credit against state income taxes.

Finding the right 529 plan given your income, estate tax situation, and other assets and liabilities is not easy, however. There are hundreds of 529 plans from which to choose, varying by provider, participation eligibility, investment management, investment options and fees.

One option that could be especially advantageous for many families could be to move some funds in a 529 prepaid tuition plan. Unfortunately many states have closed down this option; further, this move might only make sense if the beneficiary will attend a school in the state providing the plan. But there’s an out: You can generally transfer the money-market equivalent of the prepaid plan to a college in another state. So why not take advantage of this option, by putting the money you would otherwise put in a money market into a 529 savings plan? You keep more windows open for your student, and also diversify the risk of your invested funds.