Dear Mr. Market:
Most of the time that we write to you it’s about your temper or volatile behavior and how that affects the average investor. Sometimes, however, it might be good for us to refresh our memory on “why” we invest and put up with all your ups and downs! Most investors certainly don’t watch you just for chuckles ; ideally we all have a purpose and reason to put up with all of your unpredictability and potential promise. With that being said, we would like to review some basic information as well as the pros and cons of saving for college via 529 College Savings Plans.
First and foremost let’s not waste too much time on stating the obvious: College and all the costs that come with it are more expensive than they ever have been. That trend is not reversing anytime soon so if you’re a parent or a grandparent trying to prepare and plan for the future, you need to consider the enormous price tag most universities are charging. Are you sitting down? The average private college tuition in 18 years from now will cost north of $130,000…per year! OK…how about the more reasonable route of going to a public state school? That price tag is estimated to be about $41,000 per year in 2031. Before we start barking and banging the table on why you “need” to get started on saving for college now, let’s at least put the caveat out there that maybe you shouldn’t! Yes…we did say that.
It’s at least “financial food for thought”. Without delving too much into it here, the best analogy is when you’re buckling into an airplane seat before take-off. Why is it that the flight attendants suggest that in case of an emergency you should first put the oxygen mask on you as opposed to Junior? Think about it…and without sounding selfish.. but if you suddenly couldn’t breathe you wouldn’t really be able to help anyone else around you, right? The same concept could apply to your current financial situation. Many college students have the ability and option to borrow or find alternative ways to fund college costs. What about you and your retirement needs? If they hit in the next 15 to 20 years are you going to be able to wisely borrow for that or apply for a grant? No…and that could be a far more severe pickle to be in rather than having to find financial aid for a high school senior heading off to college.
Now, let’s assume you do want to save something for a future student and have arrived at that optimal amount that doesn’t cut off your own “financial oxygen supply”. What is the best way and vehicle to save for college? We believe it’s the 529 College Savings Plan and here are some of the top few reasons:
- 529 Plans are Tax-Deferred– The earnings in 529 accounts are tax-free upon withdrawal if used for qualified educational expenses. With tax rates on the rise this tax-free investment vehicle is the “no-brainer” part of the decision in where and how to save for college. Some states also offer tax deductions on all or part of the contributions.
- High Contribution Limits and Low Requirements– Just about anyone is eligible to open a 529 plan and although some plans vary, on average you can contribute up to $250,000. For those without a large lump sum the minimum requirements are also quite attractive and can be as low $25 per month depending on the plan.
- 529 Plans are Transferrable– What if Junior doesn’t go to college or use all of the savings in the plan? Unused amounts can be transferred to qualified family members without tax penalties. Believe it or not the qualified member list is quite flexible. To name a few : Any sibling, parent (even stepfather/stepmother), first cousin, spouse, in-laws, adopted children, etc…
- Easy and Convenient Management– Most plans are not only low cost but also offer age-based investment options that make it simple to manage. As the child gets older and approaches college age, the plans offering age-based options automatically reallocate to have the funds in historically more secure and less volatile portfolio mixes. Automatic contribution amounts can be set up making it a worry free and disciplined arrangement.
- 529 Plans as an Estate Planning/Gifting Tool– Wealthier individuals and married couples can also use 529 plans as a way to help reduce their estate tax bill by taking advantage of the annual tax-free gift contribution. Individuals can gift $13,000/year and married couples $26,000/year (or $65k and $130k respectively over a 5 year period if you’re wishing to accelerate the reduction in your estate size). This is known as the five-year carry-forward option: Once a single donor contributes $65,000 or a married couple $130,000, they cannot make another contribution (gift) to the 529 beneficiary (without using part of their lifetime gifting exclusion) for five years.
Lastly, let’s at least appease some of the 529 naysayers. Do they have valid points? As with anything, some do and some absolutely do not.As always, consider their vantage point. For example: If you’re listening to an “advisor” that happens to work for or is compensated by an insurance company… Simply ask them how much they would make if you went with their product (insurance offering/”solution”) versus opening and contributing to a free College 529 Savings Plan?
The argument of “you can only use the money for college” doesn’t hold much weight in our opinion. If you don’t think your child or grandchild will want the option of going to college in the next 18 years don’t open a 529 or any college savings plan for that matter. If that’s not the case consider the above no-brainer benefits. While there is a 10% penalty on all withdrawals not used for college expenses we would suggest you look at the numbers we initially began this article with. (i.e. You’ll probably find someone in the family that can find a home for those savings and avoid paying a penalty!)
A somewhat valid concern could be that your future collegian may not receive as much financial aid if they have a 529. Although funds in a 529 plan are viewed as a parental asset for financial aid calculations, they are less impactful than those held directly in the child’s name.
How about the supposed statistic that 85% of Registered Investment Advisors do not like 529 Plans? Well, consider us one of the 15% that love them. Some of the advisors that don’t “like” 529’s argue that you can only change the investments in the plan once per year. We would rather focus on the fact that you are automatically investing and saving into something and less likely to blow it! Additionally, an old saying can apply here, “the more you handle a bar of soap…the smaller it gets!”.
As always, feel free to comment or ask us any questions!