Answers to Common 529 Plan Questions

While the 529 plan landscape continues to evolve, many of the same questions remain top of mind for education savers considering these tax-advantaged investing plans. As such, we’ve refreshed this piece to address many of these important questions.

What Are the Investment Options Available in a 529 College Savings Plan? Is It Like a Brokerage Account?

While specific offerings can differ by state, all 529 plans share the same basic structure. All plans provide an age-based or target-enrollment series for set-it-and-forget-it investors, which gradually reduces their exposure to risky assets (that is, stocks) during the accumulation and savings period. These series can serve as a default choice for most investors, like a target-date series would for retirement savers. For those who want to select their own investments, 529 plans also offer a menu of one or two dozen individual mutual funds. The lineup can include a 60/40 balanced fund, an S&P 500 index fund, or more specialized products such as value, growth, or small-cap funds. Finally, plans provide an FDIC-insured account or a stable-value account as their least risky option.

Unlike brokerage accounts, 529 plans generally do not provide the ability to purchase individual stocks. In fact, families cannot take an active or trading approach to these 529 accounts, as investment changes are only allowed twice per calendar year. Contributions into the account are also invested in your preselected investment option once the check or bank transfer clears. It usually is not possible to deposit the money into a cash account and then decide when to invest.

If you live in a state that does not offer much in the way of tax incentives, you may want to shop around to find a plan that provides options that best match your investment preferences. Some plans use only low-cost index funds for their age-based or target-enrollment series, but others employ a mix of actively and passively managed funds, or focus solely on active underlying funds. Plans may even provide each of these different flavors to savers while following the same broad asset allocation. The static individual fund options also vary from plan to plan. Some offer a short list of index funds, while others provide a broad mix and include actively managed strategies from well-regarded fund families such as T. Rowe Price, American Funds, and Dimensional Fund Advisors.

Help Me Understand the Expenses. What Are Some of the Most Affordable 529 Plans?

Setting aside minute differences, the cost to an investor will be the sum of the underlying funds’ expenses in the chosen age-based or enrollment portfolio and any potential management fees. The management fee pays for the state agency that administers the 529 plan and, in most cases, the outside firm that manages the portfolio. Additional fees may include a sales charge, for those who invest in a 529 plan through a financial advisor, and account maintenance fees that typically range from $0 to $25 a year.

Currently, 14 529 plans earn a Morningstar Price Pillar rating of Low based on the average fee of their age-based or target-enrollment options. Many of these hold cheap index funds, and all 14 are direct-sold plans that investors can buy directly from fund companies, as opposed to going through financial advisors. Examples include the three direct-sold plans with the largest assets as of December 2022: New York’s 529 Program (Direct), The Vanguard 529 College Savings Plan (sponsored by Nevada), and Utah’s my529. All three hold almost the same lineup of underlying funds: Vanguard Total Stock Market Index VTSMX, Vanguard Total International Stock Index VGTSX, Vanguard Total Bond Market II Index VTBIX, and Vanguard Total International Bond Index VTIBX. They also do not charge any additional account or maintenance fees.

There are valid reasons why investors choose advisor-sold 529 plans, such as when the state’s advisor-sold plan is better than its direct-sold plan, or if the investor seeks more actively managed funds, which advisor-sold plans tend to hold more of. However, investors should note that exposure to relatively expensive funds and the additional distribution fees lead to higher overall costs. In our ratings methodology, plans with low fees relative to peers are more attractive, as the hurdle to generating performance is reliably lower than more expensive peers.

The five cheapest 529 plans covered by Morningstar analysts are listed below. The average cost of each plan’s age-based or target-enrollment options sat at or below 0.12% as of October 2022.

• Florida 529 Savings Plan
• Georgia’s Path2College 529 Plan
• Michigan Education Savings Program
• South Carolina’s Future Scholar 529 (Direct)
• New York’s 529 Program (Direct)

Conversely, there are plans that offer series with relatively unattractive fees that exceed 0.50% on average. These plans typically carry high state fees and/or high program management fees.

Does Using a 529 Plan Impact My Financial Aid Package?

The short answer is yes, but if you are saving for future tuition and expenses, you should still consider using a 529 plan, as investment gains from the account are not subject to capital gains taxes if used for qualified expenses. Also, depending on where you live, there are additional tax benefits at the state level if you invest in a state-sponsored plan.

Federal financial aid, which includes both grants and loans, is based on an estimate of what a family can contribute annually from their income and assets. Income is the largest portion of the expected family contribution, typically 25%-35% of parents’ adjusted available income (but it can go as high as 47%). The contribution from assets is assessed at a much lower maximum of 5.6%, and these assets include primarily taxable vehicles such as investment accounts, savings and checking accounts, and certificates of deposit, as well as 529 plans. (Retirement accounts such as 401(k)s, IRAs, and Roth IRAs, as well as primary residence are not included in this calculation.) So, if a family has a 529 account with $10,000, this raises the expected family contribution by at most $564, effectively reducing a federal aid package by the same amount. But aid packages typically include a loan component, so any savings that reduce the need for future loans benefit the student.

We recommend investors consult with their tax specialists regarding their specific situation.

Is It Easy to Withdraw Funds?

Yes. Accountholders can request a withdrawal to pay an educational institution or to reimburse themselves for a beneficiary’s qualified education expenses. A request can be made online, by phone, or by mail, and payment is issued either via check or electronic bank transfer. Some plans also provide auto pay. Many families pay tuition and fees first, and then reimburse themselves from the 529 plan. No documentation is needed for withdrawals. However, it is important to keep records that prove that a withdrawal is qualified, because in the event of an audit, unqualified withdrawals may translate to paying taxes on those gains. Also, money must be withdrawn from an account in the same period that educational expenses are incurred. When withdrawals begin, the 529 plan administrator will send a 1099-Q form. If the distribution doesn’t exceed the amount of the student’s qualifying expenses, then accountholders do not have to report any of the distribution as income on their tax returns.

What Happens to Money in a 529 Plan if It’s Not Used?

If a beneficiary no longer needs the money in the account (by deciding not to go to school or by earning a generous scholarship, for example), the account owner can name a new qualified beneficiary without incurring federal or state income tax penalties. Qualified beneficiaries are members of the current beneficiary’s family, which includes siblings, children, nieces and nephews, their spouses, or a first cousin. In addition, driven by the passage of Secure Act 2.0, beneficiaries with an account open for 15 years or more can transfer unused funds to their Roth IRA, allowing them to reposition the funds to another tax-advantaged vehicle. The ability to execute the conversion will begin in 2024 and will be subject to Roth IRA contribution limits, in addition to other requirements.

Subscribers to Morningstar.com can access our 529 plan reports and ratings from the 529 Plan Center map.