The Drawbacks
With all of those pros, there have to be cons, but they're pretty acceptable and easy to live with. Here they are:
  • If your child applies for financial aid, the 529 account may affect eligibility. According to

      ...the 529 account is treated as an asset of the parent or other account owner in determining eligibility for federal financial aid. This means that your expected contribution towards your child's college costs will include 5.6 percent, or less, of the value of your 529 account for each academic year. This is actually much better than the 35 percent assessment against money that is in your child's name or in a custodial account.

    The only real drawback comes in when calculating eligibility the second year. At this point, 50 percent of the money that was withdrawn from the 529 account the first year shows up on your child's tax return. This decreases your child's eligibility for the next year by 50 percent of that amount. For example, if you withdraw $10,000 from the account to pay for college expenses the first year, then $5,000 (50 percent of the total) will show up as the child's taxable income. That will decrease your child's eligibility the following year by $2,500, because there is a 50 percent eligibility assessment on the child's tax return from the prior year. (Remember -- we're talking about tax laws -- all of this can change.)

    If the student owns the 529 account, which is what happens when a custodial account has been transferred to a 529 account, then the amount of the account will greatly affect his or her eligibility for financial aid. Because the student owns the account and it is one of the student's assets, a 35 percent assessment against those assets kicks in.

  • One thing to watch out for is that the new tax laws regarding 529 plans will "sunset" in 2011. This means that lawmakers will have to make the tax change permanent before then or else the plans will revert to their original tax-deferred status (see sidebar in previous section). This possible reversal could affect you if your children will be going to college after 2011.

  • The money in your 529 plan can't be used as collateral for a loan.

  • You don't control the investments (more about how the money is invested in the next section). Your only option for changing the investments made with your money is to roll the account over to another state's plan. You can do this once a year with no penalty.

  • If you have to withdraw the money for some reason other than to pay for qualified higher education, then you pay tax (at your rate) and a 10 percent penalty.

  • You can only make cash contributions to the account; stocks can't be rolled over into it.

  • Although you are the account owner, 529 accounts are considered gifts and are, therefore, not calculated as part of your own estate assets.

  • Each beneficiary must have his/her own account. Siblings or cousins can't share an account. You can, however, roll any remaining portion of an account over to another child once the account's beneficiary has completed college.