Understanding 529 Plans: What Parents Wish They Knew Earlier

When parents begin saving for a child's future, a 529 plan is often one of the first options they hear about.

But we've found that knowing a 529 exists and understanding how it fits into your family's financial plan are two very different things.

Parents may wonder: What if my child doesn't go to college? What if they receive a scholarship? What happens to money that's left over? Should we prioritize a 529 over retirement savings?

At Sprik Financial Group, we believe those questions are worth answering before you simply start putting money into an account.

Here are some of the things parents often wish they had understood earlier.

1. A 529 Plan Is More Flexible Than Many Parents Realize

A 529 plan is a tax-advantaged account designed to help families save for qualified education expenses.

Although most people associate 529 plans with a traditional four-year college, qualified uses can extend beyond tuition at a university. Depending on applicable rules, 529 funds can potentially be used for expenses associated with other eligible postsecondary schools, certain apprenticeship programs and other qualified education costs.

Withdrawals used for expenses that do not qualify under applicable 529 plan rules may result in federal income taxes and an additional 10% federal tax on the earnings portion, unless an exception applies. State tax consequences may also apply.

That can make a 529 useful even if your child eventually decides that a traditional four-year degree isn't the right path.

The key is understanding which expenses qualify before making a withdrawal.

2. The Tax Advantages Can Be Significant

One of the primary reasons families consider 529 plans is their tax treatment.

Money contributed to a 529 can potentially grow tax-deferred. When distributions are used for qualified education expenses, earnings are generally not subject to federal income tax.

Over many years of saving, that tax-advantaged growth can make a meaningful difference. However, investment returns are not guaranteed, and 529 plan investments are subject to market fluctuations, fees, and expenses. Be sure to read the full prospectus of the 529 plan you decide to purchase.

However, contributions aren't deductible on your federal income tax return and state tax treatment varies. Because tax circumstances differ from family to family, you should consult your tax professional about how the rules apply to you. Investors may receive more favorable tax benefits from 529 plans sponsored by their state. Consult your tax advisor for how 529 plan tax treatments would apply to your particular situation.

3. Starting Early Can Matter More Than Starting Big

Parents sometimes postpone education savings because they feel they don't have enough money to make a meaningful contribution.

But you don't necessarily need to fund a child's future education all at once.

Starting when children are young potentially gives investments many years to grow. Even relatively modest contributions made consistently may build over time.

That's the same reason we encourage families to look at their entire financial plan early. Time gives you options.

Rather than asking, "How much can we possibly put into a 529 right now?" consider asking, "What amount fits comfortably alongside our other financial goals?"

4. Your Child's Plans May Change—and That's Okay

One common concern is, "What happens if my child doesn't go to college?"

That's an important question, but it doesn't necessarily mean the money will be wasted.

Depending on the circumstances, a 529 beneficiary can generally be changed to another qualifying family member without triggering federal income tax consequences. That could potentially allow unused funds to help another child or qualifying relative with education expenses.

The growing range of qualified education uses also gives families more possibilities than many parents realize.

That flexibility is important because it's difficult to predict exactly what a 5-year-old will want to do at 18.

5. Scholarships Don't Necessarily Create a Problem

Another common concern is overfunding a 529 only to have the child receive a scholarship.

There are rules that can provide additional flexibility in that situation. For example, distributions up to the amount of certain tax-free scholarships may avoid the usual additional federal tax associated with nonqualified withdrawals, although earnings may still be subject to income tax.

This is an area where understanding the rules before taking money out is especially important.

A scholarship is generally good news. Your financial strategy should help you determine the most appropriate next step rather than treating it as a problem.

6. Some Unused 529 Money May Eventually Fund a Roth IRA

One of the newer provisions parents should know about involves unused 529 assets.

Under current federal rules, certain 529 funds can be rolled directly into a Roth IRA for the beneficiary if specific requirements are satisfied. The 529 account generally must have been maintained for at least 15 years, annual Roth IRA contribution limits apply and the lifetime rollover limit is $35,000. Contributions made to the 529 plan within the preceding five years, and earnings attributable to those contributions, are generally ineligible for rollover. Additional restrictions and state tax considerations may apply. Individuals should consult their tax professionals before pursuing a rollover.

This doesn't mean parents should deliberately overfund a 529 expecting to turn it into a retirement account later.

But it does address one longstanding concern: What if there's money left after my child's education is complete?

Families now have another potential option to consider.