Does a 529 Account Still Make Sense?

  • By Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
  • July 10, 2013


Dear Carrie,

I opened a 529 account for my daughter two years ago. She’s now 14 so we have four years before she starts college. The returns have been dismal and I’m considering stopping my contributions. What do you suggest? Is this a good idea?

—A Reader


Dear Reader,

With the cost of a college education soaring, I can understand your concern. In fact, according to Education Secretary Arne Duncan, three out of four Americans think college is no longer affordable. Add to that the estimate from the College Board that 2011-12 costs for living and studying at the average in-state public university are up by 6 percent—and will keep going up at least that much annually—and students with your daughter’s timeline could face a cost of $125,600 for four years at an in-state public school. A private university could easily be double that!

While rising costs are stimulating a lot of good national debate, with some universities introducing programs to help a broader range of students, there's no uniform solution in sight. Your smartest move is to keep saving. And to my mind, a 529 is still one of the most effective ways to do it. So before you make any changes, here are some things to think about.

Consider the tax advantages

529 plans have distinct advantages tax-wise. Because potential earnings grow tax-deferred, your money has a chance to grow faster. On top of that, withdrawals are tax-free as long as you use the money to pay for qualified education expenses, which typically include tuition, books, school supplies, and room and board.

There are other ways to save, of course. But a savings account, for instance, would have negligible returns with today's low interest rates, and a brokerage or custodial account has the same investment risk with no tax advantages. A 529 stacks up pretty well by comparison.

Review how the money's invested

When it comes to returns, it's not really a question of whether a 529 account is an effective way to save, but rather how the money is invested.

When you opened the 529 for your daughter, you most likely had to choose an investment portfolio. Generally, a plan offers a choice between a static portfolio and an age-based portfolio. With a static portfolio, the asset allocation stays the same until you make a change, which you can generally do twice per calendar year. With an age-based portfolio, the fund manager adjusts the asset allocation from aggressive to conservative as your child nears college age.

If you chose a static portfolio, review the asset allocation. Was it too aggressive, exposing you to too much potential for loss? If so, you may want to change to a more moderate approach—one that keeps your money growing for the full eight years before your daughter graduates, but still protects the money you’ll need when she starts college. If you chose an age-based portfolio, ask yourself: Could you have invested the money differently and gotten better returns? Remember that the closer your daughter gets to college, the more conservative the investments should be.

Don't stop contributions, increase them

Four years isn’t a lot of time, so instead of stopping your 529 contributions, I’d ramp them up if possible—with the caveat that this doesn’t jeopardize your retirement savings.

Fortunately, a 529 allows for very generous contributions. There’s usually a lifetime limit of upwards of $200,000, and an individual can contribute a lump sum of up to $65,000 to one or more 529 plans in a single year ($130,000 for a married couple) without incurring the gift tax. If you make a special election, the IRS will view the money as an annual $13,000 (or $26,000 per married couple) gift over five years.

Not only does this give you the opportunity to put any bonuses or other windfall money into the account, but friends and family can also contribute. You might suggest that future gifts be directed toward the 529. This can be a way for grandparents to help with college costs while also reducing their taxable estate.

Factor in financial aid

Another plus is that a 529 account is considered your asset, not your child’s. So while financial aid formulas consider 20 percent of assets in a child’s name to be available for college expenses, only 5.6 percent of 529 money is factored in when applying for financial aid.

All things considered, I’d stick to your current savings plan. And get your daughter involved, too. Let her know what you’re saving, how you’re investing and what she can contribute. It will not only open her eyes to the cost of her future education, it will be a good financial lesson right now.




The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

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