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8 Common and Costly Mistakes People Make When Investing In or Withdrawing from 529 Plans

Dec 15, 2013

Getting a 529 plan is one great way for parents to save for the college education of their kids. Parents have a choice to get a prepaid tuition plan from a participating college or university and they can get units or credits from these schools that their kids can avail of in the future. Parents who choose this option get to lock in tuition prices with the prepaid tuition plan. They also have a choice to invest in a college savings plan and in stock mutual funds, bond mutual funds, and money market funds. A 529 plan is an alternative to student loans as a way to fund a college education.

Knowing how to properly invest in a 529 plan will help you avoid common mistakes that people make when they invest in or withdraw from their 529 plan. Here then are some of those common mistakes.

1) Not getting a 529 plan as early as possible- College tuition costs are rising every year. By getting a prepaid tuition plan as early as possible, parents get to lock in the tuition costs when these have yet to increase. Data from the National Center for Education Statistics shows that the total tuition in 2000-2001 at all institutions costs $13,393. Ten years later, that amount has jumped to $18,133. Those figures are set at constant 2009-2010 dollars so that comparison shows you how much you can save if you get a prepaid tuition plan early.

2) Being too conservative or aggressive when investing - For parents who choose to get a college savings plan, some may go for more less risky funds because they are conservative investors and don’t want to risk losing their investments. However, if it will take more than 10 years before your child will need the funds from the 529 plan, choosing funds that have a little more risk and has more potential for higher returns could give you more funds you could use for your child’s college education. For parents who will only start to invest in a 529 plan when there is less than 10 years before the child goes to college might want to choose a less risky fund.

3) Not looking at fees - There are fees and expenses associated with a 529 plan and it is important to understand these fees. For prepaid tuition plans, there can be enrollment and administrative fees, savings plans may also charge annual maintenance fees and asset management fees. It is possible to avoid some of these charges as some states may already cover their cost. It also pays to shop around for plans with no such fees.

4) Not using all of the plan’s benefits on eligible expenses - When it comes time to withdraw from the fund, remember that the money should go to eligible college expenses such as tuition and room and board. Spending the money on something other than eligible education expenses will make the funds subject to income tax and a 10% federal tax penalty on the earnings.

5) Withdrawing money before college–Related to what was stated in mistake number four, you need to use all of the money from a 529 plan for eligible college expenses. If your savings plan suffers losses, you may be tempted to withdraw money from the plan to cut those losses. However, you have to think about it very carefully because you will be subject to income tax and the federal tax penalty.

6) Not thinking that they cannot have two 529 plans - Parents can invest in prepaid tuition plans and a college savings plan—at the same time. Parents can use the prepaid tuition plan to lock in the cost of tuition while the earnings from college savings plan can go towards other expenses.

7) Failing to consider 529 plans in one’s tax strategy- Contributions to these plans are considered as gifts so grandparents can contribute to their grandchild’s 529 plan and thus avoid estate taxes. They can contribute up to $70,000 by front loading the plan for five years but they are barred from contributing more for another four years.

8) Withdrawing too much from the fund - Parents need to consider grants and scholarships before they take out funds from the 529 plan. These additional funding sources have to be subtracted from the tuition because taking out more will mean paying the federal tax penalty.

This plan is one of the many options parents can use to fund their child’s college education. They can talk to their financial advisor to get more information on the right strategy when they pick a 529 plan for their child. They should also read the fine-print before they sign up and get a plan. Parents should also do their homework and compare the many 529 plans that are available out there. Taking one out could help parents save their children from having to take out student or personal loans to fund their education in the future.

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