Why 529s Always Make Sense

It’s easy to explain to parents of younger children why 529s make sense: Contribute now and your account grows tax-free for 18 years until college. If you live in one of the more than 30 states that offers a tax deduction, that’s an even bigger incentive. Here in Oregon, for example, we get a tax deduction for the first $4,865 in contributions to the Oregon College Savings Plan. If I contributed that much for my newborn (well, they act like newborns sometimes) I’d get an immediate return of 9% (state tax rate) or $437.85. Suppose that my account then grows for 18 years at 5% (I’m drastically simplifying the math here), I’d have almost $12,000 when my child was ready to start college, and no tax bill to access it. Added bonus: the FAFSA and Profile don’t count that gain as income in their formulas, unlike how it would be treated if it were in a taxable account.

Of course, parents of young children have zillions of other big expenses like childcare so college savings is logically on the back burner. Fast forward to senior year and many wonder why I would still say a 529 contribution is a good idea. State tax breaks are the #1 reason why you should continue contributing to your plan, perhaps all through the college years. Most states that allow a tax deduction also allow you to carry forward excess contributions for some period of time, meaning you can continue to reap the state tax benefit for several years after college.

Plus, most 529s offer either an age-based portfolio that’s very conservative in the immediate pre-college (and during college) years, or a stable value or FDIC-insured option. Our plan, for example, has an FDIC insured option that currently pays 1.85%. This is slightly lower than the 2.25% I’d get from an online savings account, but on a tax-adjusted basis is actually higher (tax-adjusted return = pretax return/1-marginal tax rate). And my 9% return from the tax savings makes it even better.

What’s the catch? If you’re contributing during college years and don’t have a younger child to whom you could turn over excess 529 funds, check whether your plan requires funds to be in the plan for a certain amount of time before being used. Some plans require that money to be held in the plan for 90 days or even a year. And if you’re making contributions purely for tax purposes in the later years of college, find out what carry-forward provisions your state offers.

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