Five mis­con­cep­tions about 529 plans and qual­i­fied ed­u­ca­tional ex­penses

The Washington Post Sunday - - BUSINESS - Michelle Sin­gle­tary

Even though it’s been around for 21 years, many peo­ple still don’t know what a 529 plan is.

Seven out of 10 Amer­i­cans couldn’t iden­tify the tax­ad­van­taged sav­ings ac­count, ac­cord­ing to re­cent find­ings by fi­nan­cial ser­vices firm Ed­ward Jones.

Un­der a 529, if the money is used for qual­i­fied ed­u­ca­tional ex­penses, your earn­ings are tax-free.

I think part of the rea­son this sav­ings ve­hi­cle isn’t widely known stems from a num­ber of mis­con­cep­tions about how it works. So let me do some myth­bust­ing in honor of Na­tional 529 Col­lege Sav­ings Day, which falls each year on May 29.

To help, I’ve asked Mark Kantrowitz, my go-to guru about pay­ing for col­lege. Kantrowitz is pub­lisher of, a free web­site about col­lege ad­mis­sions and fi­nan­cial aid.

Here are five com­mon mis­con­cep­tions about 529s:

1. Con­tribut­ing to a 529 will hurt my child’s chances for fi­nan­cial aid.

I’m al­ways per­plexed by this no­tion, since most fed­eral aid comes in the form of loans. Sure, there’s a bit of truth to the state­ment but not enough that it should stop you from sav­ing in a 529 plan.

As Kantrowitz points out, if a de­pen­dent student or the cus­to­dial par­ent owns the ac­count, it is re­ported as a parental as­set on the Free Ap­pli­ca­tion for Fed­eral Student Aid (FAFSA). The sav­ings re­duces eli­gi­bil­ity for need­based aid by a max­i­mum of 5.64 per­cent.

“If you save $10,000 in a par­ent-owned 529 plan, need­based aid will be re­duced by, at most, $564,” he said. “That still leaves you with $9,436 avail­able to pay for col­lege costs. The col­lege sav­ings pro­vides the flex­i­bil­ity to choose a more ex­pen­sive col­lege than you oth­er­wise could af­ford. It also re­duces debt, since ev­ery dol­lar you save is a dol­lar less you’ll need to bor­row.”

2. A 529 plan means my child is lim­ited to go­ing to a school in the state where I open the ac­count.

You can use money saved in a 529 to pay for col­lege costs at any col­lege or uni­ver­sity that is el­i­gi­ble for Ti­tle IV fed­eral student aid.

“You can even use 529 plan money to pay for col­lege out­side the U.S. at one of a few hun­dred el­i­gi­ble in­sti­tu­tions,” Kantrowitz said. “You can use 529 plans to pay for two-year and four-year col­leges, as well as cer­tifi­cate pro­grams and vo­ca­tional-tech­ni­cal school. You can even use the money to pay for grad­u­ate school.”

3. The re­turns in a 529 plan are lousy.

“All 529 col­lege sav­ings plans in­clude an S&P 500 in­vest­ing op­tion that will mimic the per­for­mance of the stock mar­ket as a whole,” Kantrowitz said. “How­ever, since the stock mar­ket will drop by 10 per­cent at least two to three times in any 17-year pe­riod, it is smart to man­age the risk by us­ing an age-based as­set al­lowance. Like a tar­get-date fund, an age­based as­set al­lo­ca­tion shifts the mix of in­vest­ments from ag­gres­sive to con­ser­va­tive as col­lege ap­proaches.”

Here’s some­thing else to keep in mind. Your state may give you a de­duc­tion for 529 con­tri­bu­tions up to a cer­tain amount. Van­guard has an on­line cal­cu­la­tor that es­ti­mates what you could deduct (van­ stdc.php).

4. You can use money in a 529 plan only for tu­ition.

Nope. In ad­di­tion to room and board, the money you save can be used to pay for books, sup­plies and equipment,

in­clud­ing a com­puter, pe­riph­er­als, soft­ware and In­ter­net ac­cess. You can even pay for ex­penses for spe­cial­needs ser­vices. 5. I’ll lose my money if the ben­e­fi­ciary doesn’t go to col­lege.

If the ben­e­fi­ciary doesn’t pur­sue a higher ed­u­ca­tion, you have op­tions be­cause the money is yours. You can switch the ben­e­fi­ciary to some­one else, in­clud­ing your­self.

But let’s say there isn’t any­one else you want to give the money to or who needs it. You can with­draw the funds, but you’ll have to pay or­di­nary in­come taxes and a 10 per­cent tax penalty on the earn­ings por­tion of the dis­tri­bu­tion if the money isn’t used for qual­i­fied ed­u­ca­tion ex­penses. By the way, the 10 per­cent penalty is waived if your child gets a schol­ar­ship.

For more on this topic, read Kantrowitz’s blog post “Most com­mon col­lege sav­ings mis­takes” at

Some par­ents tell me that they haven’t set up a 529 be­cause they be­lieve their child will win enough money in schol­ar­ships.

Re­al­ity check: The av­er­age schol­ar­ship amount is just un­der $4,000 a year, ac­cord­ing to Kantrowitz’s re­search.

“Less than 1 per­cent of stu­dents win a com­pletely free ride through schol­ar­ships,” he said.

Maybe your child will beat the odds. But do you want to take that chance? In­vest in a 529 plan, be­cause hop­ing is not plan­ning.

“You can use 529 plans to pay for two-year and four-year col­leges, as well as cer­tifi­cate pro­grams and vo­ca­tional-tech­ni­cal school. You can even use the money to pay for grad­u­ate school.” Mark Kantrowitz,

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