A combination of "stagnant wages, high debt consisting primarily of student loans and high rent (rents are at historic highs relative to the purchase cost index), Gen X-ers who are in the primary demographic to use a 529 plan have little money to invest," said Bill DeShurki, a portfolio manager on Covestor, an online marketplace for investing. More than one in three workers ages 35 to 44 are not setting aside any money for retirement and for those who are ages 25 to 34, 45% of them are not saving any money, according to the Employee Benefit Research Institute.
"Therefore, Gen X-ers aren't looking into options and don't know or at this point care about 529 plans," he said. "Any investor is only going to look up investment options when they actually have money to invest."
Some parents are "more inclined to assume it's O.K. to saddle their kids with student loan debt, because that's what many of us Baby Boomers did to our kids, because we were too busy spending in the Boom years to actually save something," said DeShurki. "As depressing and pessimistic as that sounds, that is what the statistics tell me."
For the 55% that do save, the majority of them have socked away all of their savings in their 401(k)s, he said.
Maxing out a Roth IRA first is a better strategy than allocating money toward a 529 plan, said DeShurki. With a Roth, consumers can withdraw their contributions penalty free and tax free for college.
"Even if you want your earnings, they can be withdrawn," he said. "Earnings would be taxable, but there is no penalty if it is used for college. Hopefully, they save enough and can leave their earnings in to grow tax free for retirement."
One advantage of 529 plans is that you can open them with as low as a $50 initial contribution, said Derek DeLorenzo, vice president of client relationship management at Ascensus College Savings based in Boston. Once you open a 529 plan, all earnings and distributions for qualified higher-education expenses are free from federal and state income taxes, he said. The funds can be used at any eligible two- or four-year college, vocational/technical school or graduate school in the U.S.
Some 529 savings accounts offer age-based investment options that automatically become more conservative as the beneficiary approaches college age, said Keith Bernhardt, vice president of college planning at Fidelity Investments based in Boston.
Owners of 529 plans maintain control over them, so they can decide when to disburse the proceeds and change the beneficiary, Bernhardt said. Account holders also do not have to worry about income limitations, and contribution limits, including those from friends and family, do not incur gift taxes unless your contributions to a particular beneficiary exceed $14,000 in a given year.
The Downside of 529s
One major drawback to these savings plans is that you can only make one investment change annually, so reallocating a 529 plan as the market changes is not an option
Also See: Will You Be Satisfied With a 529 Plan?
"I personally dislike 529 plans, because you are only allowed one investment change per year," said DeShurki. "I don't believe in 'buy and holding' through a bear market, so I think the trading restriction is too severe to recommend them. A handful of quality stocks with compounding dividends works best for me. Sure there are taxes, but they are at lower rates than ordinary income. Stock ownership can be transferred to the student and cashed in at their (0%) tax rate when it comes time to pay tuition."
On the flip side, specific stocks, bonds and options trading are not available within 529 plans, said Bernhardt.
"For investors that want to play an active role in managing these types of investments, a regular taxable investment account or a Coverdell savings account may be a better option," he said.
Investors should avoid allocating their savings into 529 plans, said DeShurki.
"For those that have 529 plans, there is not a lot of enthusiasm to add to them," he said. "Parents think of these as 'safe' investments but saw them get pummeled in 2007 2009 along with everything else. Now that we've had a couple back to back good return years, maybe we will see more interest."
--Written by Ellen Chang for MainStreet