Welcome to MainStreet's newest series. Each week, we will answer a real question from readers on education costs and how to pay for college. If you have a question, feel free to send it to firstname.lastname@example.org.
Q: "My wife and I are debating whether to take advantage of a 529 savings plan for our two-year-old son. We’ve lived in several different states, and I imagine we’ll move around more. My wife likes the 529 because of the tax benefits, but I’m skeptical. It seems the plans are operated on a state-by-state basis, plus I've read it's better for parents to save for retirement rather than their children's education.
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My wife is a physician so many tax advantages we had during graduate school no longer help offset our tax burden. She thinks we're crazy for not using this one to help offset our taxes and provide for our son. I'd rather just manage the money myself in a brokerage account. So, who's in the right?"
- Jay, New York City
A: Jay, your wife is always right, even when she’s wrong. And in this case, she really is right.
You can save in any state’s 529 college savings plan; you do not have to save within your current state’s plan. And if you happen to like a particular state’s plan, you can keep the money in that state’s plan when you move. You can also roll the money over into another state’s plan at any time.
Distributions from a 529 college savings plan can be used to pay for college expenses at any accredited college in any state in the United States of America. So even though each state has its own 529 college savings plan, you are not tied to any state when you invest in its plan.
Perhaps you were thinking of a prepaid tuition plan, which is intended to pay for public college expenses at in-state public colleges. Most can be used for private and out-of-state colleges, and you can roll over a prepaid tuition plan into a 529 college savings plan, but the value of the plan may be diminished if you don’t use it to pay for an in-state public college. Also, many of the state prepaid tuition plans have been hiking the premiums they charge on top of a year’s tuition to compensate for actuarial shortfalls from recent stock market losses in the plans investments. With this in mind, it’s wise to not invest in a prepaid tuition plan.
The 529 college savings plans, however, are a tax-advantaged way to save for college. The investment returns are tax deferred, and distributions are entirely tax-free if used to pay for qualified higher education expenses. If you take a non-qualified distribution, the earnings will be subject to income tax at the beneficiary’s rate, plus a 10% tax penalty. This will usually save you money compared with investing in a taxable brokerage account.