Monday, September 9, 2013

Saving For Kids' College Education—What You Need To Know: TOP 10 FAQs about 529 Plans

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Does saving for your kid’s college education seem like a good idea, but that’s about as far as you’ve thought it through? Luckily for you, I’ve already gone through the pain of researching 529 plans for you (Don’t feel too bad for me—I voluntarily got a Masters in Accounting with an emphasis in taxation, so clearly I have a weird sense of what's "interesting"). Browse through these 10 FAQs and if you still have questions, shoot me a comment. I’ll either answer it here or in my next post about saving for college.

A quick note on the
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NOTE: To me, the biggest drawback of a 529 plan is it can affect the student's ability to qualify for financial aid. But my personal financial philosophy (which is somewhat pessimistic, but mostly just realistic) is that it's more important and predictable to prepare for the future relying on my own savings, rather than on any sort of government assistance (e.g. Getting any sort of social security when I retire would be neat, but I'm certainly not counting on it to be my sole source of retirement funds--so much can happen before then). I guess I figure if my husband and I are smart enough to save a lot for retirement and get to the point of having decent 529 plans, our unmarried kids most likely won't qualify for that much financial aid anyway so we're better off saving for college than counting on financial aid.

1. What is a 529 plan? Why Open One?
529 Plans are tax-advantaged accounts to help you save for higher education (aka: college). The money you contribute will be invested and (to motivate people to save for college) the government allows those contributions to grow and be withdrawn tax-free when used for qualified education expenses. Although plans cannot guarantee returns, they generally grow at market rates.  
You can check out each fund’s historical performance by going to their website. For example, Utah’s 529 plan (UESP) website is here. To see their performance, click on the sidebar's “Get the details” and check out page 45. Their “aggressive growth” performance since inception for a child 6 and under was about 10% (better than savings account rates? I would say “YES!”)

Example: You contribute $50/month to your kid's college fund. What would be the difference if you did this in a regular savings account that earned, say, 1% interest (taxed) vs. a 529 plan that, in the long term, earned about 7% (not taxed). Only a 6% difference in returns, how much could that matter? QUITE a bit, actually--almost double. After 18 years, this is how much you'd have:
Big difference, huh? Welcome to the world of investing!
What this means: Although I can’t predict the future on what market rates will be, they'll most likely be a LOT better than savings account rates. Plus, moving it out of a regular savings account will prevent the temptation to spend that money on other things.

Note: Each 529 plan must have one designated beneficiary (aka: the person you’re trying to send to college).

2. What if I want to change the beneficiary (the person who benefits from the account)?
You can change the beneficiary to another member of his or her family, as defined here.
What this means: Let's say you open an account for your first born. They choose not to go to college or they don’t use up everything you saved for them. You could roll this over to another sibling (or another relative included on this list) and use it for their college expenses.

3. What if my only child chooses not to go to college? Is that money recoverable?
If the beneficiary chooses not to attend college, another related beneficiary may be named (see question 2).  Otherwise, if the funds are withdrawn for a purpose other than qualified education expenses, the earnings will be taxed and assessed an additional 10% federal tax.
What this means: 529 plans can easily be rolled over to provide for the educational expenses of any related beneficiaries. But basically, unless you plan on dedicating your 529 contributions to educational purposes, it may not be the best choice for you.

4. What if my child gets a scholarship?
If the beneficiary receives a scholarship, you can withdraw that amount from your account without penalty or additional tax (that's good!).
What this means: If your kid gets a scholarship, good for them! You won’t be penalized. 

5. What are qualified expenses?
Tuition, fees, books, as well as room and board. And this isn't just for state schools--the money can be used for private schools, including some technical-type schools.


6. What fund should I choose?
Check out your state’s plan to start. There may be tax advantages for enrolling in your state of residence, but you can enroll in almost any state’s plan (e.g. you can live in California, enroll in Utah’s 529 plan and send your kid to college in Massachusetts). So if your state doesn’t offer anything in the way of state tax benefits and you find another state’s plan more appealing (lower plan fees and better returns), you may decide to invest elsewhere. For example, even though we live in California, their 529 plan doesn’t currently offer any state tax deduction or credit. I personally think the Utah Education Savings Plan is great so that’s where we chose to open our son’s 529 account. Each plan is completely different, so take a look at several plans, including the one(s) in your state of residence and compare different features (e.g. state tax and other benefits, fees, etc.) before choosing. Savingforcollege.com has a pretty nice way to compare 529 Plan features here. Or, for an easy at-a-glance comparison, check out their “5 cap ratings” here. 

7. Do I need to set up the plan now while my kids are young?
No, you can set up a 529 plan anytime, but realize the main advantage of the plan is to have the earnings grow tax free. As with all things that involve the time value of money, the sooner you start contributing, the (significantly) bigger your investment will grow. 

8. I’m not maxing out all my annual retirement contributions (401(k), IRAs, etc.), should I be contributing to a 529 Plan?
Maybe not. Even though 529 plans have huge benefits, they are not for everyone. Generally speaking, you should NOT sacrifice retirement for a college savings plan. To put it simply, your kids can get a loan for school, but you can’t get a loan for retirement. This doesn't give you a free pass to not save for your kids’ college education. If anything, it should make you realize how important it is to be saving enough for retirement. (Not currently saving enough for retirement? Find out how to spend less and start saving more here.)
That being said, on a personal note, even though my husband and I aren’t quite hitting all of our retirement goals right now (our goals are relatively high), we still opened up a 529 Plan for our son and contribute a modest amount each month. The reasons being: (1) It’s set up already so when relatives gave us money when he was born, for his 1st birthday, etc., we were able to put it in his college fund. (2) We hope to be able to start contributing more soon. Our particular plan has really low fees, so it’s still a good deal. Just double-check your particular plan to make sure you won’t be hit by the types of fees that would hurt your little investment.  **Also, make sure you check for ways to lower your fees, such as opting for electronic statements instead of paper statements.**

9. How much do I need to contribute to be able to pay for my kid’s college education?
Good question. Bankrate.com has a handy little calculator here. But as long as you choose a low-fee plan (many have no enrollment fees), something is better than nothing.

10. How do I enroll in a 529 plan?
a.    Directly with a 529 plan manager. Go to that plan’s website and follow the directions to “Open an Account.” It took a little effort to set up our son’s account, but it wasn’t much of a hassle and making contributions from there on out has been simple (we do automatic monthly contributions so we don’t have to think about it).
-OR-
b.    Through a financial advisor (e.g. Fidelity, Vanguard, etc.).  Also, your employer may already have relationships with advisors in connection with your retirement plan.

 
Which 529 Plan did you decide to go with and why?
 
Sources:http://www.irs.gov/uac/529-Plans:-Questions-and-Answers)
http://www.irs.gov/pub/irs-pdf/p970.pdfhttp://www.uesp.org/Resources---FAQs/Tax-Considerations.aspx

https://www.scholarshare.com/faq/ 
http://www.futurescholar.com/About/FAQ/
http://www.bankrate.com/calculators/college-planning/save-for-college-calculator.aspx

22 comments:

  1. Your skills intimidate me! You're so money hip!!! Xxxx

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  2. Excellent post! Love your blog, Lisa!

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  3. So helpful! I was just talking to my brother about this last week. I was not a beneficiary of any such college savings plan, but it makes so much sense to help your kids out if you can! Great to know about its ability to transfer amongst a variety of relatives too, if circumstances change.

    Future post idea--how do you plan to teach your kids about money, saving, spending, borrowing, budgeting? What, if anything, is allowance tied to? Maybe it'd be fun to get a variety of moms' perspectives on this!

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    1. Great comment! I actually just wrote two posts about allowance and savings accounts for children. They should pop up in about a month.

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    2. Actually two months... I'm building up a buffer.

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    3. I was going to say, Lauren is so all over that!

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  4. This is awesome Lisa! I have one question:

    We have lots of savings bonds relatives have given to our kids. Any thoughts on those? It seems like a kinda lame way to save, since as far as I understand it, you can't get the full value for 30 years.

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    1. Hey Colleen, here's an article about using savings bonds to pay for college: http://www.collegedata.com/cs/content/content_payarticle_tmpl.jhtml?articleId=10074

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  5. Great post, thanks! A follow up question I have is that I have heard about something some friends are doing for their children, which is a life insurance policy for them PLUS college savings as well - it's like all bundled together. Do you know more about this that you could share?

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    1. Hey Whitney,
      I'm not an insurance expert, so I did a little research and what I found matched my gut feeling that any sort of insurance policy is going to have relatively high fees compared with other investment accounts. That being said, there is more flexibility with what you could use the money for and you don't endanger your kids' chances at financial aid like you might with a 529 plan. But like I said, that flexibility comes at a cost. The takeaway I got from what I read is if you need life insurance for them (to cover funeral costs or something***), then buy insurance). If you want to save for college, then save for college. Some of these "two-for-one" deals ends up costing more in fees than you would have otherwise paid. The insurance salesman may make it sound great, but that might be related to the high commissions they get for selling such policies.
      Here are some articles to check out:
      http://www.bankrate.com/finance/college-finance/life-insurance-or-529-for-college-savings-1.aspx
      http://www.bhg.com/health-family/finances/work-insurance-wills/life-insurance-for-kids/
      http://www.finaid.org/savings/lifeinsurance.phtml
      ***I could go on about insurance--my personal position on any type of insurance is to only insure what you can't afford to lose. Consequently, we have hefty life insurance on my husband, but none for my children. A child's funeral costs would be tragic and unwelcome, but we keep enough cash on hand that it might empty out our emergency fund, but it wouldn't break us.

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    2. Thank you for your response! That is helpful info.

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  6. Great post Lisa! So do you always get a federal deduction for contributions and federally exempt earnings coming out (assuming for qualified expenses) but the state deduction varies by state, plan, and the way it's used? Do most states at least allow it to grow and be used tax free or is it taxed earnings going in as well as coming out? Hopefully my questions make sense but I am trying to better understand their are general state tax considerations or if they completely vary by state.

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    1. Hey Ben, great questions. Contributions to 529 plan are made with after-tax dollars (meaning no federal deduction, although some plans and states allow for state deductions and/or credits). And yes, if used for qualified educational expenses, the earnings are not taxed for federal and currently almost never for state (my understanding is that Alabama does not always conform and therefore may be taxable--random, in my opinion).
      So yes, each plan and state has different rules. For example, California does not offer any sort of state credit or deduction for contributing to their plan. However, Utah allows a Utah state tax credit for contributions to their plan (limited, of course). If you're interested in comparing the state tax treatment of plans, Savingforcollege.com has a great way to compare features: http://www.savingforcollege.com/compare_529_plans/index.php?page=select_plan_questions&plan_type_id=

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    2. This is very helpful! I have always wanted to understand 529 plans and received mixed comments from various people. So if you compare this with a 401k or traditional IRA, the difference is many states will provide you different incentives (credits, deductions, etc.) if you meet certain requirements under their 529 plan? However, a 529 plan might be more limited in the investment options as you follow the state's plan and investments. Otherwise they seem pretty similar if I understand correctly.

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    3. You could compare a 529 plan to a retirement account, although I think it would most resemble a Roth, in that there's no deduction for contributions, but the earnings and withdrawals are not taxable (when used in qualified ways); however the biggest differences are the purposes of these accounts and the rules for getting money out. There are obviously always ways to cash out of retirement plans, but there are rules and penalties designed to encourage you to leave the money in until retirement. But mostly likely, you will need money for your kids' education well before retirement, which is where 529 plans come in. So it's like apples and oranges. My personal opinion is that 529 plans are for people who are already well-funded for retirement, as in maxing out on their retirement plan contributions limits (see Question #8) and looking for tax-advantaged ways to put additional money aside for college.
      It's true that your investment options with 529 plans are more limited than with other investment accounts where you can pick and choose from a larger array of investments, but even 529 plans have different types of investments within a plan (you can select how aggressively you want to invest). To me, the biggest drawback of a 529 plan is it can affect the student's ability to qualify for financial aid. But my personal financial philosophy (which is somewhat pessimistic, but mostly just realistic) is that it's more important and predictable to prepare for the future relying on my own savings, rather than on any sort of government assistance (e.g. Getting any sort of social security when I retire would be neat, but I'm certainly not counting on it to be my sole source of retirement funds--so much can happen to our government before then). I guess I figure if my husband and I are smart enough to save a lot for retirement, to the point of having decent 529 plans, our unmarried kids most likely won't qualify for that much financial aid anyway so we're better off saving for college than counting on financial aid.
      Great questions! Let me know if you have any more. Thanks for checking out our blog, Ben!

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  7. I heard once that 529 plans have to be used for a school in the state they're for? Like if I opened an Oregon 529 plan and then send my kid to school in Texas those expenses wouldn't qualify. Is that totally wrong?

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    1. Hey HolliJo! You should be able to use distributions from your 529 savings plan for qualified education expenses at any accredited college in the US. Some vocational and international schools also qualify. Here's a handy little lookup tool to make sure the school you're thinking about qualifies (http://www.savingforcollege.com/eligible_institutions/).

      This article Lisa wrote was talking about 529 savings plans, and not a pre-paid tuition plan, which is quite different. Those are made to be used at in-state schools in your particular state. Check out this article for more information if you want (http://www.finaid.org/savings/529plans.phtml). Maybe we'll do an article on the difference between the two in the future.

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    2. Thanks Lauren! I must have been getting pre-paid tuition plans and 529 plans mixed up. It's been awhile since I looked at either of them!! :)

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  8. Lisa! So glad I found you in the blog world. Thanks for stopping by my blog. I can't wait to hear about your birth story! I am loving this blog. My husband and I have a get out of debt plan and have had lots of chats about saving for kids, retirement, investing... we know nothing! I can tell this is going to be so helpful. I might even need you to come do a post over on my blog. ;)

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  9. Lisa, this is such a great post! I am currently trying to figure out the best 529 plan for my daughter. Thank you for the information!

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    1. Glad you found it helpful, Debbie. Congratulations on your doctorate degree, by the way!

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