529s - A Better Strategy to Help Fund Your Kid’s College Education
KEY TAKEAWAYS
A 529 plan is an investment vehicle that encourages savings for higher education through tax benefits in the US.
From 2017, after sanctioning the Tax Cuts and Jobs Act. , a portion of K–12 public, private, and religious school tuition was included as qualified expenses for 529 plans. This is in addition to college education costs. (CAUTION, the state of California has not adopted this provision.)
As per the new federal rules, 529 college savings plans can be used to pay down student loan debt.
Higher education in our country is costly and it is reasonable to be worried about your child's educational future. College expenses can eat up a large chunk of your finances. In such cases, student loans can come in handy. But before getting the first loan that your student is approved for, it is worthwhile to take a step back, get guidance from experts and identify a plan that will help secure your child's future and not derail your retirement plan.
While student loans can get your child through college or school, they can also put them through some grueling experiences that steal a lion's share of their adult life. We've all heard stories of young people who work just to pay off their student loans.
However, the good news is, there are ways we can plan ahead to mitigate some of these risks and plan for contingencies.
529 plans can be an excellent savings plan that empowers students and parents alike. Let’s take a look at how it can be used to fuel money for higher education.
What is a 529 plan?
To put it simply, a 529 plan is an investment account that offers tax benefits if spent for qualified education expenses.
Currently, it can be used for the following:
K-12 tuition
Apprenticeship programs
Student loan repayments
To pay for certain college fees and expenses
It came into being as a secure act in the 1990s as a means to help make the costs associated with post-secondary education affordable. It was named after section 529 of the Internal Revenue Code 26 U.S.C. § 529.
Since growth and earnings may be tax-free, they have played a significant role in making education accessible in the U.S. It allows people to save for themselves, their kids, spouse, and grandkids. A 529 plan, if used appropriately, can have little impact on financial aid eligibility.
529 Plans Can be Divided Into Two Types
1. Prepaid Plans
As the term implies, in prepaid plans, you may purchase tuition credits in advance. That is, you pay for them at today’s rates for future use. If you think college education expenses will go higher by the time you or your child gets in, you can opt for a prepaid plan. Its efficiency depends upon tuition inflation. It is usually administered by states and higher education institutions.
The states that currently accept applications for prepaid tuition plans include Texas, Virginia, and Washington, Michigan, Nevada, Pennsylvania, Florida, Illinois, Maryland, and Massachusetts.
2. Savings Plans
A 529 savings plan usually consists of funds invested in mutual funds. The efficiency of a 529 education savings plan generally depends upon the market performance of the underlying investments. Here, investors are given a set of investment options designed to take both the performance and risk factors into consideration. It also offers age-based asset allocation options; as the beneficiary grows older, the investment turns more conservative.
It is administered by states only. However, mutual funds or other financial institutions will often undertake services like record-keeping. You’re also, not limited by the state you live in and may select any state’s plan. However, there may be added benefits, such as state tax savings, if you select your state’s plan.
What are the Key Issues Families Face When Saving Up?
1. You Don’t Have Enough Money for Expenses and Retirement
Not all families are blessed with a job that earns them enough money to meet all of their expenses, plus saving for retirement. When you have to allocate a portion of your income for the future, what you have in hand can be very little. Despite setting a tight budget, you may struggle to meet daily expenses. It makes you rethink if saving for something in the future, like college, is worth the present.
However, for many families, education is a top priority and for some, it’s the only way forward. It just may require some additional budgeting or alternative funding when your student does apply.
2. Your Debts Mount Up
Given that your income is fixed and there is little you can do about it, you may start spending more than earning. This is when you begin to overlook your current debt and the interest can start mounting up. A small delay can cost you an additional 24% on last night’s dinner, even bounced charges or tax penalties for delayed tax payments. And the repayments can limit your ability to save or spend in the future. If you find yourself in debt, you might consider a balance transfer to 0% APR credit card or refinancing your loan for a lower rate. Just be sure you have a plan to pay off that debt. If refinancing is not an option, saving up for education will seem improbable.
3. Tax Payments
Most savings and investment accounts require you as the account owner to pay tax on the interest that the sum generates. There are few saving plans, like a 529, that give you tax benefits. If you have invested in an account that offers a small interest, taxes and inflation may be adding to its inefficiency.
How a 529 plan Can Complement other Sources of Funding
There are many investment and savings plans one can make use of when saving for education expenses. 529 plans are not the only way to go. But it will often complement your existing sources of funding. Let’s see how.
A 529 plan provides borrowers an exemption from federal and state income taxes on the growth of the funds if the savings are used for qualified higher education expenses and not for other expenses.
It gives you more time to grow and compound your savings. The earlier you start, the higher the returns would be.
Opting for a prepaid plan can save you from inflation in education expenses. Since many institutions, especially private schools, raise their tuition fees every year at a predefined rate, prepaid plans can be a huge relief.
What to Avoid When Leveraging a 529 Plan for College Funding?
1. Don’t use it for ineligible expenses
529 plans have a predefined set of qualified expenses. If you use it for anything else, you’ll likely be subject to penalties; around 10%. Additionally, funds allocated to ineligible expenses are also considered as income. That means the earnings portion is taxable. Before you use your savings, make sure you have talked with your financial advisor and 529 plan provider.
2. Avoid Ill-timed Withdrawals
Make sure you don’t withdraw your 529 savings account in advance as it will also be subject to penalties. Withdrawals need to occur in the year the expense is accrued or paid. However, in the event of the student’s death or unforeseen incidents, you may be able to withdraw the account without penalty. In almost all cases you can name a new beneficiary (or student).
3. Make Sure it Doesn't Affect the Access to Federal Student Aid.
Coming to the most important part, a 529 plan can limit your access to federal student aid. When your child applies for Federal Student Aid (FAFSA), your entire family’s financial status may be taken into account. Not just the students. 529 savings will increase the Expected Family Contribution or (EFC). It considers how much a family can afford to send a member to college. One way to mitigate the risks of this is to make yourself the owner of the savings plan, rather than the students. This is often standard practice when it comes to a 529 savings plan. Depending on their school’s financial aid formula, this will lower your EFC and possibly give your student more access to financial aid.
How a Trusted Financial Advisor Can Help You Live Your Dream
The wide range of college costs, savings options, and tax laws can be confusing, and not having enough knowledge may put you at a serious disadvantage, often putting your carefully planned personal finances in jeopardy. This is where you need the expertise of a trusted financial advisor.
At Cooke Wealth Management LLC, we believe that money can be a means to achieve many of our dreams but we often need to plan carefully to get there.
As a leading wealth management advisor in Irvine, CA, we can help create a college funding plan that works for you and your children and helps them enjoy college or grad school. With qualified education loans backing your child's education, you can rest assured in the knowledge that your financial planning is secure.
Schedule a discovery session with one of our advisors today.