When I went to college (too many years ago to count now), my parents didn’t have a college savings plan. But my parents had more than just a wing and a prayer when it came to financing my college education… and it didn’t involve a 529 plan.
529 plans became a “thing” in 1996 – by which time I was already in high school. For a while, they were very trendy – when I was pregnant with my daughter, our financial adviser at the time asked if I wanted to set something up for her before she was even born (before she had a social security number! I politely declined). But eventually, I did succumb to 529 madness – and I’ve regretted it ever since.
If you don’t know how a 529 plan works, here’s a quick blurb from the IRS:
“[A 529 plan is] A plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild. Earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. Contributions to a 529 plan, however, are not deductible.”
In other words, a 529 college savings plan is basically akin to a Roth IRA when it comes to tax-free growth.
But the real question here is, does your child need a 529 plan? Is it worth YOUR time, energy, and – most importantly – investment?
For my family, the answer is increasingly no. Here’s why:
1) When you invest in your child’s 529 plan, that money can ONLY go towards education expenses. While that doesn’t simply mean tuition, it does tie your hands, especially if you ultimately have a child who eschews college for the military, the workforce, etc.
2) If you invest $50,000 into your child’s 529 plan, you can rest assured that every dime of that $50,000 will go to the school they ultimately attend. However, if you put that same $50,000 into one of your retirement accounts, FAFSA can’t touch it, and your family’s estimated financial contribution will be dependent upon your family’s income, not the assets in the 529. More on this later.
3) For most investors, the typical lead time on a 529 plan is maxed out at 18 years (ie, you start contributing at birth, and start withdrawing at age 18, when the child goes to college). On the flip side, retirement investing is typically longer-term (ie, you start investing at, say, 25, but don’t plan to make withdraws until your 60s). That gives you significantly more time for your investment to grow.
4) Because of points #2 and #3 above, it makes far more sense to invest in your 401k or Roth IRA retirement accounts before sinking a dime of your money into a 529 plan. If you still have extra money left over after maxing out these retirement vehicles, then by all means, invest in the 529!
So how did my parents pay for my school without any type of college savings plan? And how does that differ from someone whose parents used a 529 plan? Let’s take a look at 2 examples from within my own family:
My dad – who, full disclosure, is a CPA – chose not to save a lick of money for my college years. I always found this to be an interesting choice, since from a very young age, I became transfixed by the idea of attending a prestigious (re: expensive) East Coast school. I often wondered how my parents would pay for it. I needn’t have worried.
When I got into my dream school and my parents filled out FAFSA, our estimated family contribution was about $25k/year. However, my school of choice gave me a small scholarship and a few grants, which brought it down to closer to $18k/year. My parents were able to pay – on average – $14k/year, and we took out a loan (back when student loans were slightly more affordable – interest rates have since skyrocketed) for the remaining $4k/year. I graduated with just shy of $17k in debt.
My cousin’s scenario:
On the flip side, there’s one of my cousin’s, whose parents started stocking away for her education when she entered kindergarten. When 529 plans became available in the late 90s, they transferred that money into a 529 account, where it continued to grow for about 10 more years. (I’m about 8 years older than my cousin, so part of the financial differences in our situations are caused by age and fluctuating college costs). By the time she went to college, her parents had saved about $75k – but they failed to max out their individual retirement accounts first.
They filled out the FAFSA forms, and by the time my cousin graduated four (and a half) years later, the entire $75k was gone, and she still had roughly $5k in student loans. Oh – and her parents were years behind in their retirement planning, because they had put her college ahead of their retirement.
This all goes back to the tried and true saying that while you can borrow money to pay for college, you can’t borrow money to pay for your retirement. So while a 529 plan may be a great option for you and your family, make sure you do the math, run the scenarios, and ensure that you aren’t robbing Peter (yourself) to pay Paul (your child’s college education).
And as for my kids?
Yes, they have 529 accounts, but I haven’t put a lick into them in 2 years. Once you open an account and put money in it, you can’t really do anything with it (ie, I can’t transfer it to my Roth) – although my new adviser and I continue to look for loopholes to make that happen legally and without paying a penalty! I plan to help put my kids through college, but I’m doing it the way my parents did it. After all, sometimes father really does know best.