Many people begin looking into tax-advantaged 529 plans soon after the arrival of their first baby. But it can be daunting for a first-time saver (and sleep-deprived parent) to sort through the many different options, rules, and✱ tax an💞gles these accounts involve. In this article, we explore the basics of 529 plans and highlight some risks you should avoid, including picking a poor fund and prepaying tuition for the wrong school.

What Is a 529 Plan?

A 529 plan, more formally 澳洲幸运5官方开奖结果体彩网:known as a qualified tuition plan, is a way to save money to pay a child’s (or other family member’s) education expenses. The “529” comes from Section 529 of the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Code, which allows contributions to grow tax-deferred and be withdrawn tax-free if you use them for 澳洲幸运5官方开奖结果体彩网:qualified education expenses, such as tuition, room and board, and required fees.

All 50 states and the District of Columbia offer at least one 529 plan, and most provide a tax deduction or credit for 529 contributions to their plans (and some even allow a deduction if you contribute to another state’s plans). The federal government offers no upfront tax deduction but won’t tax your withdrawals if, as previously mentioned, you use them for qualifying expenses.

The Two Types of 529 Plans

529 College Savings Plans

College saving plans are what most people think of when you mention a 529 plan. They were originally designed to pay only for post-secondary education costs, such as college tuition. However, in 2017, the 澳洲幸运5官方开奖结果体彩网:Tax Cuts and Jobs Act (TCJA) expanded them to cover certain costs associated with K–12 education. Then, the Setting Every Community Up for Retirement Enhancement (💜SECURE) Act of 2019 expanded them further, allowing participants to use the money to cover expenses associated with qualified apprenticeship programs and repay up to $10,000 in student loan debt for the beneficiary or a sibling.

Most recently, the 澳洲幸运5官方开奖结果体彩网:SECURE 2.0 Act further expanded its functionality. Now, up to $35,000 of the balance can be transferred to a 澳洲幸运5官方开奖结果体彩网:Roth inꦗdividual ♑retirement account (IRA) in the name of the 529 beneficiary. This total is the lifetime maximum that an owner can contribute, and it must follow the Roth IRA annual contribution limits, so it may take a few years to meet it. The 529 account must have been open for at least 15 years to qualify for a Roth conversion.

While the states sponsor 529 plans, they may delegate the actual management of the money to large mutual fund companies and other professional investment firms. Most states offer plans that invest in different types of securities and vary in risk accordingly. For example, a 529 plan that invests in stocks may have more significant growth potential but be more vol🍨atile than one that invests in bonds or a mix of sto🐻cks and bonds.

When you open your account, you can d🅷ecide which particular plans to invest in and divide your money among several. Y𝓡ou can also move money between accounts later if you wish.

529 Prepaid Tuition Plans

The other type of 529 plan is the 澳洲幸运5官方开奖结果体彩网:prepaid tuition plan, which allows you to pay for future tuition at today’s prices at participating colleges and universities. These plans are also generally sponsored by state governments. However, unlike 529 college savings plans, the prepaid plans don’t cover room and board and can’t be used for elementary or secondary school.

🌺 There are risks to consider with either type of 529 plan.

Risk No. 1: Procrastinating

If you’re just getting started in saving for a child’s education, it can be tempting to toss some 529 plan brochures into your desk drawer and bookmark a few websites to worry about later. Putting it off is the first and probably biggest🦋 ꦡrisk that you face.

College costs tend to rise much faster than most other things. By one estimate, college tuition rises about 8% annually, twice the 澳洲幸运5官方开奖结果体彩网:inflation rate overall. This means that the price of tuition can double every nine years.

So, the sooner you can 澳洲幸运5官方开奖结果体彩网:get started, the better. Any money you invest in your child’s first year of life will have 17 or 18 years to compound, on a tax-free basis, by the time they’re re🐟ady for college.

Fortunatel🐓y, you can often open a 529 account with as little as $10 or $15 and arrange for regular monthly deposits of a similar amount through your bank account. Your employer may offer a similar plan throu♛gh payroll deductions. The more automatic you can make your 529 savings, the less you will have to think about it—and the more money you’ll likely accumulate over time.

Risk No. 2: Picking a Poor Fund

While this isn’t as prob🍎lematic as in the early days of 529 plans, some states’ funds don’t perform as well as others. Some also have higher expenses. Either (or both) of those can be a drag on the growth of your 529 balance.

If your state offers you a tax deduction or credit for your 529 contributions, one of its funds may still be your best bet, even if its performance lags a bit or its expenses are slightly higher. But remember that you don’t have to𝐆 invest in your state and are free to shop around.

Risk No. 3: A Market Crash at the Worst Pos🔯sible Time

Like other investments, particularly those involving the stock market, your 529 account balance will have ups and downs. You face a risk that it will be way down right when you need to withdraw. One hedge against that is 澳洲幸运5官方开奖结果体彩网:diversification: If you have several accounts with diff♕erent types of investments, they may not all be down🔥 simultaneously. You can withdraw from one that’s doing well and give any that are ailing some time to recover.

To help address this problem, many 529 plans now offer 澳洲幸运5官方开奖结果体彩网:target-date or 澳洲幸运5官方开奖结果体彩网:age-based funds. These funds adjust their investment strategy over time, starting aggressively (think stocks) and becoming more conservative (think bonds). The idea is that you can afford to take more risk with your money (in hopes of a greater return) in the early years because you’ll have more time to recover from losses. However, if your child is starti༒ng college soon, you'll likely want to know that the money will be there when you need it.

Risk No. 4: Prepaying Tuition for the Wr꧂ong School

Prepaid plans aren’t subject to the same market risks as savings plans, and you don’t have to decide how your money will be invested. T👍hat’s up to the plan’s managers. However, these plans have some risks👍 of their own.

First, while states sponsor the prepaid plans, not all states guarantee them, so it’s possible that your money won’t go as far as you expected—or, worst-case scenario, you might even lose it.

Besides, prepaid plans are considerably more restrictive regarding where the child can attend college. In general, a student can use the money to pay for tuition at a different school if they decide that they would rather go elsewhere. But in that event, the plan may pay less than if they went to the participating college or university you originally signed up for.

Risk No. 5: Paying 5ꦍ29 Money on 🥃Non-qualified Expenses

If you need to withdraw money from a 529 savings plan for a purpose other than qualified education expenses—such as a financial emergency of some kind—you can do that. But it will cost you. Your withdrawal will be subject to income taxes plus a 10% federal tax penalty. In addition, you’ll be expected to repay any state tax deductions you took based on those contributions.

This is one of the many reasons why it’s a good idea for families to build a separate emergency fund.

The Bottom Line

While 澳洲幸运5官方开奖结果体彩网:tax-advantaged 529 savings and prepaid tuition plans have their risks, they’re hard to beat as a way to save for a child’s education. Remember that both plans use time as their primary lever of advantage, so start as s🍃oon as possible for the best results.