Pros and Cons of Using a 529 Plan for College Savings

My family is considering setting up a 529 plan to save for college, and we're trying to weigh the pros and cons. From what I understand, it offers some tax advantages, but I'm curious about other benefits. Are there any potential drawbacks or limitations we should be aware of? Does having a 529 plan affect financial aid eligibility? I'd love to hear from anyone who's used one themselves or has gone through this with their families. Thanks!

Sure, I'd be happy to share some insight into the pros and cons of 529 plans. Starting with the pros:

1. Tax Advantages: Probably one of the biggest benefits of a 529 plan is that it offers significant tax advantages. Your 529 plan earnings are not subject to federal tax and, in most cases, state tax, as long as they are used for eligible college expenses such as tuition, room and board, required textbooks, and certain equipment.

2. Flexibility: You can use the funds in your 529 plan at many educational institutions, not just 4-year colleges. This includes trade and vocational schools, community colleges, and certain international institutions. Furthermore, as of the 2017 tax reform, up to $10,000 per year can be used for K-12 tuition.

3. Control: Unlike other education savings accounts, 529 plans allow the account holder to stay in control of the account. You can decide when withdrawals are taken and for what purpose.

Now, as for the cons:

1. Limited Investment Options: Most 529 plans offer a limited menu of investment options. This can limit your investment strategy if you prefer more flexibility in your choices.

2. Penalties: If you don't use the funds in your 529 plan for educational purposes, you could face a 10% penalty tax on the earnings. There are some exceptions to this rule - for example, if your child gets a full scholarship, you can withdraw the amount of the scholarship without penalty (though you will have to pay income tax on the earnings).

3. Effect on Aid Eligibility: And to your point about financial aid eligibility, yes, it is impacted, but maybe not as significantly as you might expect. If parents own the account, it's considered a parental asset on the Free Application for Federal Student Aid (FAFSA). As a result, it can reduce need-based aid by a maximum of 5.64% of the account's value. If the student is the account owner, it can hurt aid eligibility even more.

In sum, while 529 plans offer significant tax and savings benefits, there are also some potential drawbacks. It's important to consider these factors and possibly consult with a financial advisor to decide if it's the right choice for your family.