Overview: Once your retirement savings is on track, saving for college is another big goal for most people. There are lots of ways to save for college, but the 529 Plan offers the best options. There are no income limits to using one, anyone can give to your child’s account, the beneficiary can be changed to another child if needed, everything grows and is withdrawn tax-free if used for education, and front loading the account really boosts your gains. Use any state plan you like, but your own state might offer a tax deduction for using theirs, so check first.
Better than other accounts
If you need to save for college, the 529 is a fantastic way to do so. Money goes in (with a possible tax credit depending on your state), grows tax free, and then comes out tax free upon withdrawal if used for education expenses.
This is a better deal than saving in a taxable account because there isn’t a tax drag on your investments in the 529. It’s also better than an ESA because the contribution limits are higher in a 529. You can put $17,000 [2023] per year per child into a 529, or $34,000 per year if you are married filing jointly. Roth accounts can be used for education, but keep that money invested for retirement.
Finally, the 529 beats a UTMA account because the 529 counts less against financial aid than a UTMA account. Remember, too, that a UTMA account is the child’s money. When the child reaches the age of majority, they control the money. If she wants to sell paintings out of a van in a parking lot and use the UTMA money to fund her boyfriend’s tattoos, you can’t stop her. The 529, however, is controlled by the account owner (you), not the child. We all hope that our kids will grow up to be responsible adults, but just in case that doesn’t happen, the 529 gives you a bit more control and options later on.
Save for retirement first
Remember: retirement is mandatory, but college is optional. So, make sure you are on track with your retirement savings before affording the luxury of college saving. I would generally recommend knocking down high interest debts, saving up to the match in a 401(k) account, and funding Roth IRA’s before getting very far into saving for college. YMMV. A child’s diploma won’t feed you in retirement. Kids can work to pay for college, they can go to an affordable school with lower fees, and they can even get loans if they have to. Therefore, don’t kill yourself saving for college at the expense of your own retirement. I was an RA in one of the dorms at Purdue, which paid for my last two years of school. My sister got a full scholarship to school. If your child ends up like we did, it would have been better to have more money in your retirement accounts than saved up for higher education.
Use any state plan
All states provide a 529 plan, and no matter where you live, you can use any state’s plan. No matter which state your child attends college (or studies abroad), the 529 money can be used no matter which plan it’s in. It’s best to check out your own state’s plan first, because they will often give you a tax credit for doing so. I’m in Texas with no income tax, so I use the Vanguard plan (Nevada) because it has fantastic options with low fees. Utah, New York, and Ohio are some others that use low-fee funds. Also, if you move, find a better plan, or feel stuck in a bad plan, you can always transfer your funds to a new state plan. I switched from the Ohio to the Nevada plan a while ago and all it took was a notarized form and a few days to transfer.
Have more than one
Maybe your state offers a tax benefit for making 529 contributions, but you aren’t happy with the investment options within the plan. In this case, have two 529’s! If your state gives you a $2,000 tax deduction and you plan on investing $12,000 per year, you could: Invest the first $2,000 in your own state’s plan for the tax deduction, and put the last $10,000 into a better plan, like Utah, Ohio, NY, or Nevada.
Switching the Beneficiary
One of the best features of a 529 plan is being able to switch the beneficiary. You are the account holder and your child is the beneficiary. To be a beneficiary, he or she needs a SSN. I started saving for our children’s college before they were even born. I did this by being both the account owner and the beneficiary at the same time. This allowed us to get a head start on saving, which is important due to compounding. When each daughter was born and her SSN was received, I’d open a new 529 account and transfer the assets from my name to hers. Easy. There are other benefits to this, too. What if one of your children doesn’t go to college? Transfer their assets to another child or cousin. Another option is to simply leave the money in their account. If or when they have their own children, they can transfer that money (that has now been compounding for decades) to their own children’s accounts. That then saves them the hassle of saving for their own kids. Or, transfer the money back to yourself and get that second degree you always wanted. This flexibility is what makes the 529 amazing.
Front loading isn’t just for washing machines
The IRS allows people to front load 529 plans up to FIVE years worth. Married filing jointly gift limits are $34,000 [2023]. Times five is $170,000. This is what the very wealthy do, and it’s really smart: Drop all $170k into their child’s 529 account the day it opens. They then never have to save again because that much money compounding for 18 years is more than the child would ever spend in undergrad school. MBA, med, or law school, anyone? The point is that if you have a wealthy relative that wants to unload money prior to being hit with an estate tax situation or just be generous, the 529 is flexible enough to handle that situation.
Withdrawals or Cashing out
There are a lot of expenses that are covered by the tax-free 529 plan. Tuition, room and board, fees, books, computers, and even meal plans are covered. If you buy a house for your child to live in off campus with the plans to sell it after graduation, you can even pay yourself back with the rent money charged. The rent just can’t be more than the room fees of the dorm. As always with tax related account spending: Keep receipts and good records.
Hopefully it never comes to this, but you can always get a lot of your money back if you absolutely have to. Like an IRA, you pay a 10% penalty and income tax on any gains. Ouch. Try not to do that. Penalties might be waived for things like the death of the beneficiary or scholarships, but cross that bridge when you get there. Instead, I’d look at ways to transfer those assets to some other family member first. Or send them to me – I have four daughters, haha.
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