Dear Dr. Don,
I'd like to know if a Section 529 plan can be used as a tax deduction along with a retirement plan. Or, do you have to choose one or the other? Also, what happens if our kids do not attend college? Can the money be rolled over into our retirement or can we eventually close the account?
-- Sandra Savings
Section 529 qualified tuition plans are funded with after-tax contributions, at least on the federal level. Some states do offer a tax break on contributions made to 529 plans, or income exemptions on qualified withdrawals (at least on the state-sponsored plans in that state).
If your children don't go to college -- or better yet, don't need the money because they're on full scholarships -- you can't do a tax-free rollover of the money into a tax-advantaged retirement account.
You can close the account, but you'll owe income taxes on the investment earnings and possibly a 10 percent penalty tax. Since you contributed after-tax dollars, you've already paid federal income taxes on the contributions.
The Saving for College Web site, run by Bankrate's College Money Guru, Joe Hurley, explains it all in the College Savings 101 feature "What is the penalty on an unused 529 plan?"
From a financial planning perspective, I think you should put retirement savings first when deciding between contributing to a tax-advantaged retirement savings account or a Section 529 plan. Counting on your children to support you in retirement is a low-probability solution to meeting your goals for retirement.
For most retirement plans, you have some option to tap the funds for education -- even if it's just a plan loan from your 401(k) plan. For education plans, there's no option to tap the funds for retirement.