I keep seeing LinkedIn posts from financial advisors going into great detail about why they don’t recommend 529s for their clients. And I hear countless stories of families who don’t have college savings, largely because someone told them not to use a 529.
Here’s the thing: there are tons of great reasons to use 529s. The simplest is, you’ll have more money available for college because of the tax savings. There aren’t many good reasons not to, but here are some of the rationales advisors use to tell people not to use 529s:
- “You’ll get more financial aid if you don’t have a 529 because 529s count against you. You should use a taxable investment account/Roth IRA/insurance policy instead.” If that person suggests that you use a taxable investment account instead, they simply don’t know how financial aid works. Yes, a 529 is an asset, but so is a taxable investment account. But 529s are better for financial aid than taxable investment accounts because the 529 doesn’t generate taxable income, either from dividends you receive on an ongoing basis or from capital gains when you sell the investment to pay for college. As for the Roth IRA? Sure it doesn’t count as an asset, but when you take the money out it’s income on the FAFSA and CSS Profile. That means it counts at 47% of its value. So, $10,000 in a 529 will reduce your financial aid by $560, but taking $10,000 from a Roth IRA will reduce your financial aid by $4,700. As for the insurance policy? No no NO.
- “529s aren’t flexible. What if your child doesn’t go to college?” 529s are actually incredibly flexible. You can change the beneficiary to another family member, use it for K-12 tuition or a trade school or apprenticeship programs, or roll $35,000 to a Roth IRA. You can also take a distribution and just pay the taxes on the earnings. Furthermore, less than 1/3 of Americans don’t do any additional schooling beyond high school, so chances are good that your student will have educational needs that your 529 can pay for.
- “529s don’t have enough investment options.” It’s true that your 529 is more like your 401k than your IRA, where you have a set menu of investment options including target date fund-like investments. Most 529s use index funds– low cost, broadly diversified mutual funds that have historically delivered equal or better returns over extended time periods than actively managed mutual funds, and at lower cost. (If your state’s 529 doesn’t offer index funds, use Utah’s my529 instead.)
- “What if your student gets scholarships and you don’t need the 529?” While it’s true that most students get scholarships in some form, less than 1% get full ride scholarships covering tuition, fees, room, board and books. The other 99+% need some more money.
There’s a reason a lot of advisors don’t like 529s, and it has nothing to do with making sure that you have money available for college. Instead it’s this: if you put your college savings into your state’s 529 plan, the advisor usually can’t charge you a management fee for it. There, I said that part out loud. If you are saving for college and working with an advisor who tells you not to use a 529, ask them whether they’re a fiduciary to you because it’s unlikely that that advice is in your best interest.
