Starting any savings plan is a long-term commitment so there are things you should consider, such as penalties and restrictions, before opening a 529 plan. Other things to keep in mind include:
Potential gift tax penalty
Individuals are eligible to contribute $75,000 gift-tax free to a 529 plan in a single year, while couples can contribute $150,000 tax-free. Although this may not apply to the broad, middle class population, a gift tax penalty, or recapture, may be imposed on contributions under two conditions: if an individual or couple makes any additional contributions greater than the maximum gift tax limits within five years, or if the contributor passes away before the five-year period has expired.
All 529 savings plans have associated fees such as maintenance and enrollment, however some plans incur higher (and more fees) for different services. For example, investors opting for an advisor savings plan purchased through a financial agency should be aware that these plans generally have a higher upfront cost than buying plans directly through a state provider. All plan fees and their resulting impact should be considered before making a selection.
Restrictions and penalties
Just as qualified education expenses are tax-free, using 529 funds for any non-qualified expense is subject to income taxes and also to a 10 percent federal penalty. It is relevant to consider and understand all of the conditions in which 529 funds can be used so that families avoid improper spending and related penalties later on. Federal penalties also exist for overdrawing funds and, coincidentally, for under-using account funds.
Available time to save
Another important thing to consider is how much time you have to save before needing to use your 529 funds. This matters because it affects your investment strategy and by extension, which plan you may choose to begin with. As with most savings accounts, starting earlier is best, however that isn’t always an option for everyone. Analyzing different investment tactics and their outcomes for your specific situation can be a game-changer.
While investing in a 529 plan is much more reliable than “putting it all on black” at a casino, there are still related risk outcomes. For example, either due to external or internal forces, it’s a possibility that you don’t meet your target savings goal and have to rely on alternative means to help pay for college expenses. To avoid this scenario, account holders and contributors should monitor the progress of their 529 plan and make any necessary adjustments along the way.