A 529 plan is a good investment for parents thinking ahead on how to cover the college costs of their children. There are very nice tax benefits, too. However, like any investment, you must make an informed decision before taking the plunge. Below are 4 pitfalls to avoid and certain risks to watch out for.
1. Doing nothing.
Time is on your side and the biggest mistake you can do is succumb to paralysis of analysis. It can be daunting to invest in a 529 plan for a first-time saver but this can only ever work to your advantage. College costs have an average inflation rate of 7% and regular savings accounts, even the best ones, only have about 1.3% yield. If you are going to take care of your child’s education expenses, you will need the tax advantage boost from a 529.
2. Trusting the market.
Choosing the savings-plan route means you trust that your fund’s investment portfolio will do well enough to raise the money you need for your child’s college costs. But there is one big challenge: market volatility. What if the market falls when you need the cash? If you are still willing to take the risk, at least invest in age- or time-targeted funds. This does not remove all risk but it minimizes it. Watch out for fees, too. They can be very high.
3. Buying prepaid tuition.
This is a tricky one. Basically, you are buying tomorrow’s tuition at today’s prices. How sure are you that your prepaid tuition plan is not under-funded? There is no guarantee that your prepayment will cover the actual college tuition for your child when the day comes. It is very likely that you end up with sizable extra assessments and new fees to cover funding shortfalls. Flexibility is always a good feature when you are trying to save for college, or anything at that.
4. Spending on unqualified expenses.
In case something goes wrong, you can repurpose the money in your 529 savings fund on something outside of education. The principal will always belong to you. There are penalties to consider though. You will lose the tax benefit and must repay any state tax deductions based on contributions. A 10% federal penalty applies on earnings, too. Ideally, you will have an emergency fund ready so your 529 plan will remain undisturbed.