Common Mistakes to Avoid with a 529 Plan

The cost of going to college has gone up quite a bit this past 20 years. As of 2013, the average cost for a private (not-for-profit) college including room, board, tuition and fees is just over $43,000 per year.

Should your child opt for a public university, that figure is just under $20,000 – crazy number, considering this is in state tuition.

We have discussed some of the vehicles to help you pay for your child’s college – and a 529 plan is one of the best ways to conquer the high costs.  The 529 plan allows you to invest money without paying federal income tax. It’ll also allow to to avoid paying income tax on the money you take out – provided it’s used for qualified educational expenses (including tuition, room, board, books, etc.)

Before you rush to open up an account, you want to be aware of how they work, some of the myths that surround 529 plans AND… some of the mistakes many people make when they open up a College 529 plan:

#1 – Pulling out Money to Pay for other Expenses

Your 529 plan is not an Emergency Fund – so don’t assume you can pull out when you need extra bucks. You can, but you will pay a penalty.

Withdrawing early to pay for life expenses will cause you to pay a penalty PLUS taxes on the earnings. Not to mention .. if you take out early, you jeopardize the money you do have in there – reducing your ability to save enough before your child heads to college.

#2 – Starting TOO Late

It’s smart to think about your child’s college when they are newborns – or not long after.  Don’t put it off to the point that you start thinking about it when your child hits their teenage years, as time won’t be on your side.

It’s common to put it off, assuming your child will get a scholarship, use loans OR, because you assume they won’t go to college. But why not plan ahead and take advantage of putting away – if you can? 

You do not have to wait until your child is born to start a 529 plan – you can make yourself the plan’s beneficiary then change that beneficiary when your child is born – we did that with our 1st — and we were able to change it soon after she was born and had her Social Security Number.

#3 – Not Checking the Account Often

It’s important to open a 529 plan, but it’s equally critical that you check it periodically too.  Some 529 plans allow -pre-set portfolios with an age based option – that start more aggressive and taper off to a moderate level as the child gets older. If you aren’t going to be able to rebalance your 529 plan annually, then try to get into an age-based portfolio to ensure you are adjusting your portfolio often.

#4 – Not Using it for Qualified Expenses

NOT every college cost is a qualified expense that you can pay with a 529 distribution. For example.. you can’t pay for student loans with your 529 plan nor can you pay for transportation.  Be familiar with what is qualified and what is not, so you can avoid using your distributions on those things that aren’t in the 529 plan allowance.

#5 – Withdrawing too Much Money

When you withdraw from your 529 plan to pay for tuition, make sure you match the expense with the withdrawal as carefully as you can – which means you should take into consideration the scholarships and grants your child might receive too. 

If you pull out $15,000 and only need $13,000 (because your child got a scholarship) … you’ll pay $500 in federal tax (if you are in the 25% tax bracket) on the extra $2,000 – unless of course you use it for other “qualified” education expenses. Which is why it’s important to take out the proper amount and also determine what things are a qualified expense.

#6 – Not Reading the Fine Print

529 plans can be a great opportunity to put away for your kids – but they aren’t the only way to contribute money for college. It’s important to familiarize yourself with all of the other college savings vehicles out there, too.

Many states offer a 529 prepaid tuition plan that allows you to contribute money now to lock in your tuition at a state university in the future.  Some states offer a guarantee your return (Florida, Mississippi, Washington or Massachusetts), but not all. If you are not in those mentioned states, then your money might not cover your child’s education if tuition outperforms your investment…

#7 – Not Thinking about the Fees

Just like investing in mutual funds, 529 plans also charge a small percentage of your investment to cover the costs of operation, and costs can vary greatly.  Some states offer 529 plans for a lower fee than if you were to visit a broker – who might charge slightly more.

And while the fees might seem very little at first, they can add up quite fast, especially if you are investing over a long period of time.