Why 97% of People Don't Use 529 College Savings Plans (2024)

FAQs

Why 97% of People Don't Use 529 College Savings Plans? ›

It's easy to see why Americans don't embrace 529 plans. They often have limited investment options, high fees, complicated rules and anxiety-producing investment risks. All that said, the plans may ultimately be worthwhile for most families, as long as parents choose carefully. Focusing on fees is crucial.

The account owner can easily change the beneficiary at any time, or worse, they can take a non-qualified distribution and liquidate the plan. This might become an issue in case of divorce, or if a parent depends on a grandparent or other relative's 529 plan to pay for their child's education.

Drawbacks of a 529 plan

Nonqualified expenses may incur penalties of up to 10%. Some state plans charge high fees that can eat away at your earnings. Investment choices may be limited. 529 plans could reduce the scholarships and grants your child could receive.

If you use distributions from your 529 account to cover anything other than education costs, you will face a penalty. You will be able to withdraw your money from the account but will be responsible for income taxes on the earnings – federal, state, and county if applicable – as well as a 10% penalty fee.

Tax benefits and a new Roth IRA feature make 529 college savings plans attractive, but they're not a one-size-fits-all option. There are many different approaches to saving for college, but 529 plans are used by more Americans than any other option — 30% of Americans use a 529 plan.

Investing in your child's education with a 529 college savings plan has its advantages, which may also include some tax benefits. Plus, changes to the tax code have added elementary and secondary school costs to the list of education-related expenses you can pay with money from a 529 college savings plan.

A 529 savings plan is generally an all-around good choice to pay for your child's (or your own) college, while a Roth IRA may be a better option as a backup account to supplement educational expenses.

It's easy to see why Americans don't embrace 529 plans. They often have limited investment options, high fees, complicated rules and anxiety-producing investment risks. All that said, the plans may ultimately be worthwhile for most families, as long as parents choose carefully. Focusing on fees is crucial.

In most cases, your 529 plan will have a minimal effect on the amount of aid you receive and will end up helping you more than hurting you. You can also take several steps to increase your child's eligibility for student financial aid.

So, if your child opts out of college, you can name a younger sibling or even a niece or nephew or potentially another relative. And you can even name you or your spouse as the beneficiary if you're interested in furthering your education.

What happens to 529 money if you don't spend it? ›

If you don't need the account balance for a near-term purpose, you can leave it untouched in case a relative needs it for graduate school or your spouse decides to pursue an MBA. You can continue investing in your 529 for years, preserving the account's tax benefits.

The Roth IRA also offers benefits in terms of available investments, unlike the 529, where investment choice is limited to funds that may not offer low-expense options. That's not the case with a Roth, which allows you to invest in nearly anything that trades on a public market.

Like other types of investments, particularly those involving the stock market, your 529 account balance will have its ups and downs. You face a risk that it will be way down right when you need to make withdrawals.

529s are funded with after-tax dollars, which means that over time the investments grow tax-free. These plans are attractive for wealthy families because they provide a way for a parent or grandparent to transfer much more money to a child than they would be able to without incurring gift taxes, Stokes says.

In June 2022, the average 529 balance was $25,903. In June 2021, the average 529 balance was much higher at $30,287. The vast majority of 529 funds are in 529 college savings plans, not 529 prepaid tuition accounts.

Is it better for a grandparent or parent to own a 529 plan? Many advisors will push people to have the parent own the 529 plan because recent rules have grandparent contributions hurting total financial aid eligibility.

One of the main drawbacks of saving in a 529 plan is that you owe a penalty if you use the funds for an ineligible expense. If you do need to withdraw funds or use them for noneducation-related expenses, you'll incur a 10% penalty and owe taxes on any investment gains.

So, if your child opts out of college, you can name a younger sibling or even a niece or nephew or potentially another relative. And you can even name you or your spouse as the beneficiary if you're interested in furthering your education.

You don't lose unused money in a 529 plan. The money can still be used for post-secondary education, for another beneficiary who is a qualified family member such as younger siblings, nieces, nephews, or grandchildren, or even for yourself.