Should I invest in a 529 plan?

Josh Nowack

October 23, 2015

When I'm asked a question three times in a week, it's time to do a blog post about it.  529 plans take their name from the section of Internal Revenue Code that governs their use.  Officially, they are called Qualified Tuition Programs and they allow for the prepayment of higher education costs on a tax-favored basis.  

There are two types of programs: prepaid plans, which allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary (child) won't be starting college for some time; and savings plans, which depend on the investment performance of the fund(s) you place your contributions in.

You don't get a federal income tax deduction for the contribution, but the earnings on the account aren't taxed while the funds are in the program. You can change the beneficiary or roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.

Distributions from the program are tax-free up to the amount of the student's qualified higher education expenses. These include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.

The downside is that if funds are used for something OTHER than education (changing the beneficiary is okay), the earnings are taxed at ordinary rates AND subject to a 10% penalty.  Ouch.  

Any school on the Department of Education list for student loans qualifies.  This would mean that most colleges, universities, vocational and tech schools will qualify.  

The contributions you make to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is $14,000 for 2015. 

Now, is investing in a 529 plan a good idea?  Well - it depends.  Let's just assume for a second that you have a reasonable indication that your child will attend college.  Like, when I was growing up, so long as I was breathing, going to college was not optional - I was going.  Fund your reserves first.  There is NO "cents" having an education plan when you have no emergency fund money.  Also, fund your retirement plan to its maximum level first.  You can borrow to fund college.  You cannot borrow to fund your retirement.  If you have discretionary cash remaining, then go for contributing into the 529 plan. 

So, you've contributed into the 529 plan - where should I put my money?  Well, most 529 plans have some pretty stringent investment options - this means your mutual fund selection is pretty slim.  Which one to pick?  Sorry - call me and I'll arrange a consultation with my financial advisor who'll be delighted to advise you based on current market conditions.  

If you would like to further discuss how the qualified tuition program might help to meet your child's future college costs, please give me a call.


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