Grizzly BullsWhy Everyone Should Be Talking About the Secret Superpower of 529 Plans
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529 college savings plans might not be the most glamorous topic around, but they're getting a lot more love these days---and for good reason. According to data from the College Savings Plan Network (CSPN), total 529 plan assets hit a record $473 billion in 2023, skyrocketing from just $250 billion in 2016. Clearly, people are catching on to the potential of these savings vehicles.
The surge in interest makes sense when you consider that 529 plans offer tax benefits and a smarter way to save for the increasingly expensive goal of higher education. In fact, for those who start early, a 529 plan can grow into a hefty nest egg, especially if they can resist the temptation to raid the account early for non-qualified expenses (but we'll get to that).
Currently, a good chunk of 529 assets are parked in low-risk options like savings accounts or conservative mutual funds. Why? Because families often need access to that money within a few years to cover tuition or other educational costs. But for those who start saving early---especially when the kids are still learning their ABCs---there's a strong case for taking a more aggressive investment approach. After all, 529 plans boast some serious tax advantages: tax-free contributions, tax-free compounding, and tax-free withdrawals if used for qualified education expenses. It's the ultimate triple threat in the world of college savings.
The Magic of Long-Term Compounding (With a Side of Tax Benefits)
If you're able to leave your 529 plan alone to grow for a decade or more, you're giving your investment the ultimate sidekick: compounding. Let's say a parent kicks in $5,000 a year for 10 years into a 529 plan, earning an average annual return of 6%. After 10 years, the balance would have swelled to more than $70,000, thanks to the magic of tax-free compounding.
Meanwhile, another parent who opts to save in a taxable brokerage account could invest $4,000 each year after taxes (assuming they're in a 20% tax bracket). If they also earn a 6% annual return, they'll wind up with around $58,000 after 10 years. That's a decent return, but it's not $70,000. Plus, when they pull the money out, they'll have to pay capital gains taxes on the growth, meaning they'll take home even less.
529 plans, on the other hand, sidestep those tax traps---so long as you're using the funds for educational purposes like tuition, textbooks, or even room and board. But be warned: the IRS is watching. If you use 529 funds to buy something like, say, a car (yes, people try), you'll get hit with taxes and a 10% penalty on the earnings portion of the withdrawal.
How Should You Invest Your 529 Plan?
The question of how to invest your 529 plan depends largely on one thing: how soon are you going to need the money? If your child is about to hit college next year, you probably don't want to be rolling the dice on high-risk stocks. But if you've got a newborn and plenty of time before they're applying to Harvard (or clown college---no judgment), a more aggressive portfolio of stocks could pay off handsomely.
As your child approaches college age, it makes sense to dial back the risk. Most 529 plans have what are called age-based portfolios, which do this automatically. They're like a robo-advisor, but with way less fanfare: they start aggressive when your kid is young and gradually shift to more conservative investments as the college years get closer. By the time your student is filling out their FAFSA form, you're probably sitting on a mix of bonds and cash equivalents, which help protect your balance from any last-minute market crashes.
How Does a 529 Plan Fit Into Your Overall Strategy?
While 529 plans are great for covering education expenses, you should think carefully about how they fit into your broader financial strategy. For example, should you prioritize funding a 529 plan over maxing out your retirement accounts? As much as you want to give your kid the best education possible, remember: there are no student loans for retirement.
So, the general advice is this: make sure you're meeting your retirement savings goals before funneling all your money into a 529. Once your retirement accounts are in good shape, then you can go all-in on the college savings front.
Don't Forget About Estate Planning
A lesser-known perk of 529 plans is how well they work as estate-planning tools. Got a grandparent looking to pass on some wealth? They can make five years' worth of 529 contributions in a single year---up to $85,000 for an individual or $170,000 for a married couple---without triggering the gift tax. It's a win-win: the grandparents reduce their taxable estate, and the grandkids get a head start on their education savings.
But what happens to the 529 plan if the original beneficiary (your child) decides they want to skip college? Fortunately, the account owner (you) can change the beneficiary to another family member---cousins, siblings, even yourself. Yep, that's right: you can use the funds for your own educational pursuits, whether that's going back to school or taking an online coding bootcamp.
529 Plans vs. Roth IRAs: Which One Wins?
When it comes to deciding between a 529 plan and a Roth IRA for college savings, it's a bit like comparing apples to oranges, but there's some overlap. Both offer tax-free withdrawals---529 plans for education, and Roth IRAs for retirement---but they differ in flexibility. Roth IRAs allow you to withdraw your contributions (not the earnings) penalty-free for any reason, including college expenses. So if you want more flexibility and don't mind using your retirement account to cover education costs, a Roth IRA could be an option.
However, 529 plans still come out ahead when your goal is to max out education savings. They allow higher contributions and offer state tax deductions or credits in many cases, which gives them a leg up in pure savings power. But for ultimate flexibility, Roth IRAs are tough to beat.
The Bottom Line
529 plans might not seem flashy, but they're quietly one of the best tools for building up a college fund with tax-free growth. Whether you're saving for your child's education or thinking about going back to school yourself, a 529 plan can offer big benefits. Just remember to plan your investments according to your timeline, think about how it fits into your larger financial picture, and avoid using those funds for that shiny new car (seriously, the IRS will know).
