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What are 529 accounts? How do they work? What are the pros and cons of using one?

They seem like a really good option, but I would like to hear from people who have used them.

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Mark’s Answer

529 Plans are financial accounts that allow you to save money for education tax free. Generally, there are limits to what you can deduct from your income when you put money into the accounts, but any growth in the account (interest, capital gains, etc.) are tax free.

When an account is set up, you designate a beneficiary - the person for whom the account is set up (you can change this later for any reason). Then, depending on your state, some or all of your contributions to the account are tax deductible in your state.

Most states don't give you many options for how your account is invested.

There are several benefits to a 529 plan:
- Your growth is tax free. Assuming a 6% compound growth rate, that means that if you invest $5,000 a year for the first 10 years of your child's life, when they turn 18, they will have over $110,000 available for education expenses.
- You can use the money for any qualified education expense, not just tuition. It can include room and board, books, and other education materials.
- In many (if not all) states, you can use the funds for things other than undergraduate education. Private school, graduate school, and non-traditional schools may be acceptable expenses in your state.
- You are not limited to plans in your state. While you may not get the state income tax deduction if you invest in another state's plan, you will still get tax-free growth.
- You can change the beneficiary of the plan at any time. If your oldest child gets a scholarship and does not need all of the funds on their 529, you can change the beneficiary to another child. Or yourself (for continuing education expenses).
- Others can contribute to the same account. Contributions are considered "gifts" from a tax perspective, and this year the limit is $16,000 per contributor. For couples, I believe this is doubled. Other family and friends can also contribute to the account.
- You can actually use a portion of a 529 to pay off student loans for previous education expenses.

There are other benefits, but these are the main ones of the top of my head.

As for cons:
- Most 529 plan investments are pretty conservative. This is not always a con, but in some years you might do better investing outside the 529 and still taking the capital gain tax. If you are a savvy investor, you may be able to do better investing on your own.
- While you can open a 529 in just about any state, the plans are not consistent. Some plans are better than others, and as I mentioned above, the best plan for you might be in another state. Finding the "best" plan can be daunting, so most people just choose their own state's plan.
- Penalties do exist. Many people will have have the 529 funds sent directly to the school, but if you withdraw the funds, you need to make sure that they are paid for qualified expenses in a reasonable time frame. For example, if you withdraw a full year's tuition at the beginning of he school, year, but don't pay the second semester's tuition until that semester, you'll incur a penalty.
- Depending on your income level, you may not benefit from a 529. If a married couple earns less than about $80k, they won't pay capital gains anyway. So they don't benefit from a 529.
- 529s count against the account owner when considering student aid. This is not a big issue if the owner is the parent, but if the account is owned by the student, it can significantly affect your aid eligibility.
- Fees happen. Like any managed brokerage account, there are fees associated with the account. Often, they are based on a percent of the account's value. So as your account grows, so do the fees you pay to manage the account.

Overall, 529s can be a solid part of saving for college (or other education). They are not for everyone, in every circumstance. But they are an option worth considering.

Hope this helps!

Mark recommends the following next steps:

https://www.bankrate.com/investing/529-plan-benefits/
https://www.bankrate.com/investing/529-plan-disadvantages/
https://www.nerdwallet.com/article/investing/529-plans-by-state
Thank you comment icon Wow! Thanks for the insightful and informative answer! Genevieve
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Kyle’s Answer

Hi Genevieve,

First, here is a great article from morningstar that provides an overview of 529 education savings plans and recommendations:
https://www.morningstar.com/articles/1095553/what-is-a-529-college-savings-plan

Two of the benefits of 529 plans are:
(1) your contributions grow tax-free and can be withdrawn tax-free to cover qualified educational expenses like tuition, mandatory fees, books, a computer, internet access, and room and board.
(2) some states, like your state Kansas, provide state income tax benefits for contributing to a 529 plan

That first benefit, tax-free growth, is much more impactful when you have many years for your contributions to grown. Many people start 529s when their kids are young, to take advantage of this benefit. I see from one of your other questions that you expect to graduate college with a first degree in 2023, work for 2-3 years, and then go back to school. So, you don't have as much time to take advantage of tax-free growth, and with that timeframe you'll most likely want to invest conservatively, since your funds will be needed in the short-term. Every tax dollar saved helps, and you'll still save taxes on any growth; a 529 is just not as compelling as if you had many more years before needing the funds.

That second benefit could reduce your Kansas state income taxes and reduce taxes for anyone else who contributes to your 529 account. For Kansas residents, contributions to Kansas AND non-Kansas state-sponsored 529 plans of up to $3,000 per beneficiary per year by an individual, and up to $6,000 per beneficiary per year by a married couple filing jointly, are deductible in computing Kansas taxable income.

Kansas has 2 or 3 state-sponsored 529 plans, none of which are rated gold or silver by morningstar. Take a look at "The Top 529 College Savings Plans":
https://www.morningstar.com/articles/1006084/the-top-529-college-savings-plans-of-2020

Since you can get the Kansas tax benefits using non-Kansas 529 plans, I'd recommend investigating the three 529 plans that morningstar rates as gold:
1. my529.org , sponsored by Utah. I used this one and highly recommend it.
2. brightstart.com , sponsored by Illinois
3. misaves.com, sponsored by Michigan

After investigating these, you can decide if you want to open a 529 account, or keep it simple, and invest funds that you have earmarked for college in regular taxable accounts.

Good luck!
Thank you comment icon Very informative! Thanks! Genevieve
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Ira’s Answer

A 529 Plan can be used to save for certain educational expenses for a student planning to go to college. Such educational expenses include college or other post-secondary education, qualified higher education expenses and in many states monies can be used as well for tuition for elementary or secondary public or private schools. The individual for whom the account is opened for is called the beneficiary or the student. Typically, the account holder and the beneficiary can be the same person. One can start to consider saving for a 529 plan as early as one can, but should take into account your family's overall financial situation.

One of the benefits of a 529 plan is the tax free earnings that grow over a period of time. Therefore, the longer the money is invested, the more time it has to grow and the greater your tax benefits.
Thank you comment icon Thank you so much! Genevieve
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