Parents and grandparents often want to do something to help Junior build a college account and the 529 Plan can seem the natural choice. After all, how can you beat tax-deferred growth – and penalty-free access for college expenses?
Not so fast. Here are five factors you need to know before taking the 529 plunge.
- Risk – the money you put into a 529 plan is exposed to market risk
- More Risk – there is no way to lock in gains – so bad years can wipe out good years – or worse
- Tax – money is taxable as withdrawn. It may be at Junior’s rate – but it will increase the tax on Junior’s lawn-mowing money
- Use-it-or-Lose-it – If Junior doesn’t go to college – the money can’t be accessed without penalty until retirement. No trade school – no business seed capital
- FAFSA Penalty – The FASFA form inventories your – and Junior’s – income and net worth to determine how much financial aid your may qualify for – versus the “Expected Family Contribution.” Money in a 529 Plan reduces financial aid dollar-for-dollar.
Here’s an alternative. Put money into an indexed universal life insurance policy for Junior.
- It’s very low cost – probably in line with the costs/expenses in a 529 Plan
- The money will grow tax-deferred, but is accessible tax-free
- There is no risk of loss of principal or gains
- Junior will have a bit of life insurance and locked in his “insurability” for life
- He’ll get a free long-term care benefit that probably won’t be needed but is nice to know is there
- Even if it is used for college – the plan can continue – and become a sweet retirement account or be accessed for another life need, tax-free
- The accumulated value IS NOT COUNTED on the FASFA form and therefore does not reduce qualification for financial aid
General rule: Anything that has a government stamp on it is usually better for the government than for you. The 529 is the centerpiece of that theory.