A 529 plan is a higher education savings plan, which derives its name from the section 529 of the Internal Revenue Code. As college education and tuition fees grow costlier year on year, many parents invest in these plans to assure their children of good education. However, there are some downsides to these plans, which need to be considered before you make an investment.
It is important to understand that the 529 funds are often susceptible to volatile changes in the market. The recent recession left the value of many 529s eroded as prices dropped in almost all segments of the economy. Even as many managers of 529s tweak their investments to restrict exposure to high risk financial assets, the fact remains that the 529s failed to meet expectations during the economic downturn.
A 529 plan makes sense when parents invest for their child very early so that the plan has a 10-12 year period to yield results. This period should be adequate to smoothen out the effects of volatile conditions and swings and it could show good results. A 4-5 year period will simply not suffice to build up a good fund. Given the current economic volatility, chances are you may end up with capital erosion if things get bad.
Significant federal and state tax breaks are offered with a 529 plan in the form of zero tax liability on returns earned as long as the funds are used for higher education. However, some states may impose limitations on this too and there are many states where there is no state level tax break for a 529. Furthermore, the benefit of a tax break only arises if you get good gains from the fund, which has not happened for the last 3 years.
The many options within 529 plans are often confusing and difficult to analyze or compare. There are more than 3,000 possible 529 plans when you consider all the options and sub-options within each plan. What’s more, the lack of structured performance reporting makes it difficult to find the best suited plan. A financial advisor may help you with this choice but his fees and other charges will increase your costs. The 529 plan can also be quite inflexible with only a small window every year to change your investment strategy.
With so many disadvantages, a 529 plan might not be the best option available to you. You may be better off saving for college through a regular deposit or other investment products.