Saving for future education costs is a crucial financial goal for many families, and 529 plans can be an effective way to achieve this. However, managing a 529 plan to maximize its benefits is just as important as opening the plan in the first place. With rising education costs, it's more important than ever to stay informed and up to date on any new rules and changes.
Read on to learn more about common pitfalls in managing a 529 plan and how you can make informed decisions in pursuit of a brighter educational future for your child.
Waiting Too Long to Contribute
Opening a 529 plan is a great way to start saving for future education costs, but if college plans are still years (or even a decade or more) away, it may be tempting to put off making contributions. There's plenty of time to catch up, right? While it may not seem like a top priority today, procrastinating on making contributions or neglecting the account could mean missing out on years of potential compound growth. Putting your money away early lets it get to work and start building potential returns.
Although contributing even a small amount might seem challenging initially, establishing a plan, contributing whatever is possible, and doing so consistently is crucial. Many plans now offer automatic-investment programs, a helpful tool that simplifies making regular contributions at a chosen dollar amount.1 While it's always possible to increase contributions later, investing small now is more important than investing big later to leverage potential compound growth.
For example, investing $200 per month from the time a child is born until the day they turn 18 could grow to nearly $78,000, assuming a 6% rate of return. By contrast, investing $400 a month from ages 10 to 18 would have only amassed about $49,000 (also assuming a 6% rate of return). Investment returns are not guaranteed, and you could lose money by investing in a 529 plan.
Less Can Be More if You Start Early
Assuming a 6% rate of return. The investment examples provided assume no expenses or fees. Actual returns may vary based on market conditions and any applicable fees or expenses. This hypothetical illustration is not intended to reflect the performance of any particular 529 plan or its investment options, whose actual rates of return will fluctuate.
Unrealistic Return Expectations
As with any investment, 529 plans are subject to market fluctuations, and growth isn't guaranteed. While 529 plans offer tax advantages and the potential for growth, their performance depends on market conditions, which can fluctuate significantly over time. Overestimating growth could lead to underfunding, leaving families with less than they had anticipated for college costs.
In addition, many plans often shift to more conservative investments as a beneficiary approaches college age, which could lead to lower returns. To avoid financial shortfalls, it's important to maintain perspective, set appropriate goals, and regularly review progress, adjusting contributions and strategies as needed.
Stopping Contributions During Market Downturns
In times of volatility, it may be tempting to stop making contributions or turn off automatic payments. However, market downturns may also lead to cheaper share prices that could grow substantially when the market rebounds. And since timing the market is impossible, avoiding the market's worst days may also mean missing out on the potential benefits of an eventual market recovery. History shows that missing just a few of the market's best days can lead to lower overall returns.
Since 529 plans have a limited timeframe for growth, contributing consistently and staying the course during a downturn ensures that long-term plans remain intact. When the market does inevitably fluctuate, it's important to stay focused on the long term and avoid panic selling.
Prioritizing College Savings Over Retirement
Many parents hope to help their children avoid the burden of student loans, but prioritizing college savings over retirement savings can be detrimental to their own future retirement plans. While there are various ways to pay for college, such as scholarships, grants, and loans, retirees don't have the option to borrow money to fund their retirement. This means retirees are heavily dependent on the amount they've saved. Failing to save sufficiently before retirement could leave finances strained and shift a financial burden to children, as they may need to help support parents or other family members later in life.
Even more, sacrificing retirement savings early in life could limit future financial growth. Just as with 529 accounts, retirement accounts (e.g., 401(k)s and IRAs) can benefit significantly from compound growth. Delaying contributions could end up significantly reducing the amount of money available when it's time for retirement.
Balancing both savings goals is ideal, so setting clear savings priorities and getting other family members involved in education savings can help make this daunting task a little more manageable.
Using Funds on Unqualified Expenses
Since 529 accounts are specifically geared toward education savings, there are some rules around how these funds can be spent. All earnings in a 529 account grow tax free and withdrawals are also tax free, as long as they’re used toward eligible qualified expenses. Qualified expenses include college tuition, supplies, room and board, equipment, vocational or technical training, K-12 private-school tuition,2 apprentice programs and fees,3 and more. Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal income-tax penalty. Such withdrawals may also have state income-tax implications.
Review your plan’s resources to make sure purchases are qualified to help avoid any unnecessary penalties.
Overlooking Other Potential Penalties
While there's no limit on how much can be withdrawn from a 529 account in any given year, there are a few specific limits on qualified expenses that are important to know: No more than $10,000 each year can be used toward private or religious K-12 tuition expenses. For funds that are used toward any qualifying student-loan repayment, which can include both private and federal loans, there's a lifetime limit of $10,000. Any amount over these limits may be considered a nonqualified withdrawal and may incur income tax and a 10% penalty on the earnings portion of the excess amount.
And for account owners and beneficiaries considering rolling over funds into a beneficiary-owned Roth IRA, the following conditions must be met for penalty-free rollovers: the 529 account must have been opened for at least 15 years; the amount rolled over must have been in the account for at least the last five years; and rollovers have a lifetime limit of up to $35,000, as well as being subject to annual IRA contribution limits.
Average total costs and projected costs of 4-year college tuition, room, and board:
Source: The College Board, “Trends in College Pricing and Student Aid,” 2024. Based on average total charges for tuition, plus room and board for one year (2024-2025) amounting to $24,920 at a public, in-state, four-year college, and $58,600 at a private, four-year college. For illustrative purposes only. Assumes 4% annual increases. Future college expenses may be higher or lower than the amounts shown.