Last year, college savings accounts could only be used for qualified college education expenses. Now, 529 college savings plans can be used to pay for elementary school. The tax overhaul that passed in December included legislation to expand the use of 529 plans to cover tuition for K-12 education. While these plans are supposed to be used for your child’s education, the money in your account can be used for different situations. To help you figure out what you should do, we asked experts about the pros and cons of 529 college savings plans.
Pro: Savings Plans Become More Versatile
A 529 plan can help you put away money tax-free for your child’s future education – even if the future is just in one year. If you happen to have the money to save for the present and the future, then it isn’t a bad idea. As you would with any decision, make sure it’s worth it for you. “Do you have a reasonable expectation that tapping into 529 account to fund costs associated with public, private or religious school, elementary and secondary education will pay off in the long run with better performance in standardized testing, college admission and access to merit scholarships by your student,” says Mary Morris, CEO of Virginia529.
Con: Scarce Resources for College Savings
Public elementary and secondary schools are free, but public college generally isn’t free for most. So, if you don’t have enough money for college, tapping into funds early makes it difficult to pay for a college education and also increases the amount of student loan debt for yourselves or your children. “The first step is to determine how much you ultimately want to save for your child’s education,” says Chris Hunter, spokesperson for the College Savings Plan Network. You can use CSPN’s college cost calculator to figure out savings needed for future college costs.
Pro: You May Receive Interest Earnings
Even if you only save for two years, account interest grows. If you invest in the stock market, investment growth may get trickier. If stock market prices fall, there isn’t always time for the market to recover. If you invest $5,000 for two years, earning just 1% interest, your savings still go up by $100. Also, this interest is federal tax free.
Con: Money Doesn’t Grow Much
One of the main benefits of a 529 plan is interest accumulating, so, there isn’t as much of an advantage if you withdraw the money before it can accrue interest. “My concern for families considering withdrawing for K-12 is that they’ll lose out on compounding interest,” says Bob Cole, president of the Private College 529 Plan. “Families won’t see the money grow much by early withdrawal.”
For example, if you deposit $5,000 for one year with 2% earnings, the money grows by $100. If you left the same amount in your account for 10 years and experienced annual 5% earnings, you add $3,200 to your original deposit without adding another penny.
Pro: You Could Receive a State Income Tax Deduction
Maybe you won’t have an opportunity for the money to grow much via interest and earnings, but you could benefit from a state tax deduction. For instance, if you live in a state that has a $5,000 per person, per beneficiary tax deduction and your income tax rate is 5%, you’d save $250 on your taxes as a single filer and $500 for a joint return, if saving maximum amounts per child. However, this is a combined deduction for all education.
Con: Your State May Have Their Own Rules for Tax Free Contributions
Your state may not offer the deduction for K-12 education or may even recapture taxes if you use previous savings for K-12 education. “We are monitoring the changes closely and working with each state to determine how the expansion of 529 plans – to include K-12 tuition expenses – works in their state tax code,” says Hunter. “Each state is also considering how future changes to its tax code best fits the needs of the state and its citizens.” For more detailed information, 529 plan participants should check their plan’s website and disclosure materials.
Figuring out how to use your college savings account can be difficult. College is expensive, and you may not want to pull out money from your savings accounts for earlier education. Check state tax carefully, and consider your priorities within your education savings goals.
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