How sure are you that your child will go to college?

Posted by Matt
I've been looking into 529 savings accounts again and I keep coming back to that question about whether we are really sure we will need it. But before we explore that, let's start off with the basics.

A "529 plan" is an education savings account named after the section of the IRS code that defines it. I first researched them in 2006, shortly after my son was born, and decided against them because the tax advantages were originally set to expire in 2010. I just discovered that the Pension Protection Act of 2006 has made them permanent and decided to take another look.

Here are the benefits:

• Earnings grow tax-free
• Contributions are deductible from state income taxes (up to $2000 for Oregon) in some states.
• The funds can be used for qualified expenses at any accredited public or private post-secondary institution in the United States and abroad (this can even include online education).
• When the government assesses a student's need for financial aid, the value of the 529 plan is assessed at an expected family contribution rate of 5.6% (assuming the parent is the account owner). Other college savings that are in the name of the student are assessed at a much higher rate of 20%.
• You must designate a beneficiary, but the beneficiary can be changed within the family.
• If the beneficiary receives a scholarship, you can withdraw funds from the account up to the amount of the scholarship without penalty. The earnings portion of this withdrawal will be subject to federal and state income tax at the account owner's rate.

This all sounds great. We started a regular savings account for our son already, but I like the idea of getting it into a mutual fund (which is one of the typical options for 529 accounts) for better returns and letting it grow tax-free. The state tax deduction is also a great bonus.

My concern is around what happens to the money if our son doesn't go to college. If I just had to pay the back taxes on the earnings, that would be fine. Unfortunately, if you end up withdrawing the money for anything other than education expenses, you ALSO have to pay a 10% federal tax penalty. Which brings me back to the question, "How sure are we that our child will go to college?"

I'll chalk it up as another one of the great uncertainties of financial planning, but we will be pushing our son towards at least SOME type of post-secondary education, so I think a 529 does make sense. It's not my favorite place to put our money, and I've often read that education should not come at the expense of other types of saving (i.e., "there are no scholarships for retirement"), so I'll probably make sure we get our Roth IRAs maxed out first (especially considering Paul's last post).

My final caution is to (as always) shop around. 529 plans are administered by states, but you don't necessarily have to pick the plan for the state you are living in. The expenses for some plans could outweigh the benefits, as described in this article from Slate. Luckily, that great article Paul found yesterday had a link to a 529 guide that can help you get started.

Update 10/3/07: Here is another great article on 529's.