With the average cost of tuition and fees at private colleges exceeding $43,750 in 2021-22—while out-of-state public college students are paying nearly $30,000 per year—saving for college might feel like a monumental task.1 For many parents, 529 college savings accounts may be a way to invest for your child’s future while perhaps saving money on taxes in some states. However, these 529 accounts have some challenges that may lead you astray if you do not pay attention. Here are four of the costliest 529 mistakes you might make.
Missing the Annual Deadline
Unlike IRAs, which allow you to contribute funds for the previous year by the tax filing deadline, 529 plans operate on a calendar year basis.2 This means that if you do not make your annual contribution by midnight on Dec. 31, you miss the opportunity for that year. Some states allow exceptions. It may be worth considering breaking down a yearly amount into weekly, biweekly, or monthly contributions to ensure that you are on time by the end-of-the-year deadline.
Not Investing Your 529 Funds
One of the key benefits of a 529 account is the ability to invest contributions in stock index funds, mutual funds, and other publicly-traded investments. If you set up contributions but do not go any further than that, your 529 funds are likely to sit in a money market account earning a small amount of interest.
Investing involves the risks that might increase or decrease your account balance, particularly during times of high inflation. Nevertheless, it is worth considering your time horizon while considering investments with the help of a financial professional. An asset allocation for a one-year-old might be more aggressive than for a 16- or 17-year-old who hopes to use their 529 funds in the next couple of years. Some 529 accounts offer target-date funds that shift their investment holdings each year, becoming more conservative as the withdrawal date gets closer.
Not Making Qualified Withdrawals
Ideally, you withdraw your 529 funds in ways that manage federal income taxes, including avoiding taxes on gains.3 However, these benefits apply only for withdrawals to pay qualified expenses.
Qualified expenses include:
- Tuition for elementary, middle, and high schools (up to $10,000 per year)
- College tuition
- Books and school fees
- Room and board (either the actual cost or the allowance included in the school’s cost of attendance)
You need to spend all withdrawals from your 529 account within that calendar year. This rule means that if you make a withdrawal on Dec. 27 but do not pay for the next semester’s tuition or the bill for room and board until Jan. 2, the distribution may not qualify due to not being used within the same calendar year. The same goes for costs covered by scholarships or grants. If you make a withdrawal and another source pays the qualifying expense, the distribution may not qualify.
Paying a Penalty if Funds Are Not Spent
A scholarship is always something to celebrate. However, suppose you plan to use a 529 account to pay for your child’s college, only to realize that your child no longer needs financial assistance. In that case, you may wonder whether you are resigned to cashing out the account and paying the associated penalties.
Fortunately, 529 accounts are flexible. You may be able to name another child as the beneficiary. You might save the account for your grandchildren. You may choose to save it for your child to use for postgraduate tuition and fees. You may even use it for your continuing education or that of a spouse, parent, sibling, or another family member.