How ought to I save for my kid’s school? Plus a 529 plan hack
How should I save for my child’s college? A common question regarding 529 plans, Coverdell educational savings accounts, and even an IRA 529 plan hack.
Today’s classic will be republished by The doctor philosopher You can see the original Hise.
If you’re reading this blog, chances are you’ve heard of using a 529 plan while saving for college. Today we’re going to discuss 529 plans, my thoughts on when it’s a suitable vehicle, and alternative ways to finance college education.
I should note that this post isn’t focusing on how to choose the right 529 plan. For this I would suggest the following simple formula:
Check your home state to see if there is a tax break for investing in the 529 plan. If a tax break cannot be found in your home state, look for a plan with low fees, index fund options, and flexibility.
Some plans that are commonly referred to as the Number 2 Qualification include those offered by Nevada, Utah, California, and New York.
Should I even save for college?
Any reasonable conversation about saving for your child’s college education should begin by discussing whether saving for college should be a goal at all. You may think we’re going to look at the downstream effect of paying your child’s college education … but as much as I love talking about how to prevent young adult claims, this post is not going to go there.
The question I’m trying to answer is, should you invest in your retirement or in your child’s college education? If this becomes an either-or question (i.e., you can’t afford to save enough for retirement and save for your goals by a certain age AND save for college), I find it helpful to have a second one To ask a question.
Do you think your child would rather take out loans to pay for college or have a high chance of having to pay for their medical care and living expenses in their older years? For most, the answer is clear. You’d rather pay for college.
Unless you have calculated that you are investing enough to retire at a comfortable age, this should be your first priority. Don’t save up for your child’s college education if you haven’t planned on taking care of yourself first.
Trust me. Your kids would rather take out college loans than pay for their expenses later in life and get a free college education.
Okay, now that we’ve got this out of the way, let’s move on to the good stuff.
Unique Benefits Of A 529 Plan In Saving For College
The most common question about 529 plans is whether people should be using one. Why not just deposit money into a taxable account when you are saving for college?
The basic benefit of a 529 plan is that you can bring in after-tax money and, as long as it is used for education expenses, the money and the interest it accrues will not be taxed again. It works essentially like a Roth IRA, but for education spending instead of retirement.
One benefit of a 529 plan is that by using a plan you have “marked” an account specifically for the sole purpose of paying for college. Having a separate account like this is a great way to have a disciplined savings plan. Especially when the money is automatically transferred to the account after each paycheck.
As mentioned in Recommendation # 1 for Choosing a 529 above, attending a 529 in your home state can also provide a tax benefit.
There is one other thing to mention. When you open a 529 plan, you’ll need to designate a beneficiary. Fortunately, you can always change the name. When your oldest gets a full ride to college, you can pass it on to their happy younger siblings.
Alternatively, you can leave the money in the 529 account and use it for graduate school expenses if they go that route.
Or, you can use the 529 hack mentioned next.
The 529 Plan Hack Scholarships
If you take money from a 529 for an unqualified payout (that is, money that is not used for education expenses), there will be a penalty of 10% plus tax on the income. This leads some people to avoid participating in a 529 plan because they fear that Junior will get a full ride and they won’t be able to use it.
However, there is a hack to avoid this 10% rule. I mentioned that you could designate a different beneficiary if your elder deserves a full ride. Let’s say it’s no longer your oldest child. Instead, it’s your only child. Or let’s say they decide to go to military school. In this situation, they get a full ride to accept a military engagement after college.
Instead of naming a different beneficiary for the 529 plan, you can simply take the same amount of money as the earned scholarship from the 529 plan. The nice thing about it is that there is a rule that you will not face the 10% penalty plus tax for unqualified withdrawals in this particular situation.
For example, let’s say your child deserves a $ 20,000 scholarship. Then you could take out $ 20,000 and spend it on a trip to Hawaii or just deposit it into your taxable account.
However, it should be noted that you will continue to be taxed on the winnings you have made within the account. This essentially turns your 529 “Roth” account into a 529 “Deferred Compensation” account that is subject to income tax on all income. For this reason, some prefer to move the beneficiaries with the remaining 529 funds to future generations.
Use other accounts to fund college
You can choose to use a 529 plan over the other options available. However, you should at least know about the other options!
One option that is often overlooked is using IRA (Individual Retirement Account) funds. Yes, IRA money. You can withdraw funds from these accounts for education expenses. If you use IRA money on education expenses, you will not be affected by the 10% withdrawal penalty. Even if you are less than 59 1/2 years old.
So, if you have money in a traditional IRA or Roth IRA and you think it appropriate to use that money towards your children’s college expenses, be my guest. It works the same as a 529 plan, except that revenue on a traditional IRA account may be taxed differently than on a 529 plan.
Coverdell Education Savings Accounts (ESAs) are another choice for higher education savings. The problem with this is that there is an income limit (you cannot contribute if you are married and earn> $ 220,000 or single and earn $ 110,000). Plus, you can only contribute $ 2,000 per year.
Another option, of course, is to use money from a taxable account to fund the college. You might even consider converting more of that money into bonds as your child approaches college age. The hope would be to cover the cost of attendance as your child approaches college age.
Investing in college can be a major financial goal for people with children. The takeaway here is to take care of yourself and your retirement first. Then consider saving up for college and be smart.
If you decide to take part and your child gets a scholarship, know that you can avoid that 10% penalty by hacking the 529 account if you so choose. However, you will have to pay income tax on any income you withdraw.
Do you intend to pay for your child’s college education? How do you deal with it? Did you know about the different options that 529 plans offer? Leave a comment below.