10 Myths About 529 College Savings Plans

Find out whether you should stash cash in one of these accounts College isn't getting any cheaper, and you may feel it's at least partially on you to fund your child's higher education. Those 529 college savings plans, named after Section 529 of the Internal Revenue Code and run by state organizations, sound like they're chock full of benefits, but is there a catch? Here, common misconceptions about 529 plans and the truth from financial experts. Photo by Thinkstock.

Myth: You can open a 529 account only through your home state's plan.

Actually, most states don't have residency requirements. "While there may be good reasons to stick with your own state's 529 plan (including tax benefits-keep reading), you're free to shop the dozens of others," says Joe Hurley, a 529 plan expert and founder of SavingforCollege.com. Your best move: Compare plans from several states. Choose one that includes investment options you like, such as low minimum contributions or an "age-based" selection that automatically adjusts your investment mix as your kids get closer to college.

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Myth: You can open a 529 plan only in the state your child attends college.

No one can predict where your child will end up, so thankfully, this is false. "Money saved in a 529 plan can be used at any college, in any state, regardless of where the plan was opened," says Raymond Loewe, a chartered financial consultant and founder and president of College Money, a college-planning firm in Marlton, NJ. The money also can be used at many eligible foreign universities and for study-abroad programs (but check if you're unsure). The general test for 529 eligibility: If the student can apply for a federal Stafford loan for the school.

Myth: Only your state's 529 plan offers you tax breaks.

Not necessarily, though your state's plan may afford you tax breaks. However, "a handful of states offer 'tax parity,' meaning you may deduct your contributions to any 529 savings plan from your state income taxes," says Gary Busch, a certified financial planner in Houston. Since several states-including California, New Jersey and Massachusetts-don't allow deductions for 529 contributions, and some states have no income tax, there may not be an incentive to stick with your state. Again, shop around. "The best plans are directly sold (no commission) and invest in low-cost index funds. Any tax advantages for investing in your home state's plan are usually less important than keeping your expenses low," advises Busch.

Myth: Only parents can open 529 plans.

Grandparents, aunts, uncles, siblings-even your beloved next-door neighbor-can establish a 529 plan for the benefit of your child. Also, most plans-but not all, so check the fine print-allow people other than the account owner to contribute, says Hurley. So your account could be a great place for relatives to deposit birthday, holiday and other special-occasion cash gifts for your kid.

Myth: If you haven't opened a 529 plan by the time your child starts grade school, it's too late.

Not so. As with any investment, the earlier you put money in, the more time it has to grow. But you can open a 529 account pretty much anytime-even when your child is already a college student, says Loewe. You'll still benefit from tax-free growth of your money for a few years-and every little bit helps. And on the other end of the spectrum, you can open an account before your child's born. Just name yourself as the beneficiary, and once your little one has a social security number, make her the beneficiary on the account.

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Myth: If your child doesn't go to college, you lose all the money in your 529 plan.

Nope. In that event, you can change the beneficiary to another child in your family-or even yourself, if you'd like to go back to school-says Loewe. Also, there's no penalty for withdrawing money from your plan if your child doesn't need it because she earned a scholarship. If you change your mind about owning a 529 plan for other reasons (maybe you need the money for something else), you're entitled to 100% of your contributions, without penalty. But you'll have to pay taxes, as well as a 10% penalty, on any money the 529 account has earned.

Myth: Your child controls the money in the 529 plan.

You own the account; your kid is simply a beneficiary, so she can't change the investment options or withdraw money without your consent. Busch says the only exception-and this would be pretty unusual-is if you or another relative transferred money to a 529 account from a Uniform Gift to Minors Account (UGMA) or Uniform Transfer to Minors Account (UTMA). Then, your child would gain control of the account on her 18th or 21st birthday, depending on your state's rules.

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Myth: 529 plans disqualify kids from receiving college financial aid.

"There's less impact on financial aid than you think," says Loewe. Money in 529 accounts is considered a custodial asset, meaning it's yours if you opened the account. Financial aid formulas that determine how much tuition you will likely pay are designed to spare parental assets when possible. "The formulas count approximately 5.6% of the parents' assets and 20 - 25% of the student's assets," Loewe explains. Hurley adds that your parental income (not savings) is the biggest factor in that calculation, and 529 plan withdrawals don't count as income.

Myth: Your child has to go to a public school if you fund higher education through a 529 plan.

"529 plans don't restrict which colleges you can attend," says Loewe. Hurley thinks some parents mistakenly assume the plan is only for public schools because of another type of 529 plan: a prepaid state tuition plan that about a dozen states offer their residents. "That's geared toward families intending to send their children to in-state public schools," says Hurley. Even with a prepaid 529 plan, you can convert the money for use at private and out-of-state institutions, but it might be a lower value than you'd get if your child attends an in-state public school.

Myth: Your 529 account can never lose value.

Say it ain't so: Just like any investment account, "your 529 can drop in value if it's invested in stocks and/or bonds, as most are," says Busch. The flip side: If you keep your money in "safe" investments, such as certificates of deposit (CDs), it's not likely to keep up with the rising cost of tuition, says Busch. According to Hurley, a good middle-of-the-road option is an "age-based" investment option. Your investments are mostly in stocks while your child is young, and they automatically shift to bonds and money-market funds, which are more stable, as your child approaches college age.

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