Disclaimer: This is an unsponsored post. This article is intended to be a general resource only and is not intended to be nor does it constitute financial advice. Any recommendations are based on personal, not professional, opinion only. Past performance is not indicative of future results. For illustrative purposes only.
Saving for college tuition is a thought that makes most parents break into a cold sweat. For a child born in the last 5 years, it is estimated that the cost of that child’s college education will be something around $250,000. And that’s for a public school. While some people are fortunate enough to be able to afford that easily, the vast majority of parents will need to have a savings plan in place very early if there is a desire to help children pay for higher education. There are various ways to save for college, such as traditional cash savings accounts, trust accounts, and bearer bonds. But, today one of the best ways to save and invest for a child’s higher education is with a 529 plan. In fact research shows that more and more parents are opting for 529 plans over other savings options. In response to several inquiries that we have received, this month RocklandNYMom’s own Money Momma will explain 5 facts about 529 plans.
1. The best part about a 529 plan and what makes them so popular is that they grow tax deferred. This is a really big deal when it comes to saving up a large amount of money. With most other types of savings accounts, the government taxes the money earned. (This is a general statement. How and what the government taxes depends on the investment itself). These taxes are a fee the government collects in exchange for earning money in our capital markets. For most savings accounts they collect this fee all throughout the life of the savings account. A 529 plan is permitted to grow in value without having to pay this tax fee to the government. Theoretically, this tax treatment allows the account value to increase at a faster rate than if the account was subject to taxes. In other words, it’s a really big deal.
2. 529 plans have plenty of investment options to pick from. The right investment option typically depends on the age of the child as well as the guardian’s risk tolerance. For example, a child who has 10 years before they enter college can take on more risk than a child who enters college in 2 years. The reason for these differences is that if the account loses value in the market, there is still plenty of time in the 10 year scenario to earn that money back. If the account loses value in the 2 year scenario, the money may be needed before the account can recover what it lost. A good rule of thumb is that a market cycle is 5 years. If there is more than 5 years before college, appropriate risk should be considered in order to have the best chance at returns. Growing the account is the #1 priority when there is a considerable amount of time before the money is needed. As the child gets closer and closer to the time these funds will be used, preserving the account becomes the #1 priority and risk should be reduced.
3. One of the most misunderstood facts about a 529 plan is what happens to the money if the child chooses not to attend college. If the child does not go to college, the money comes back to its owner, most likely the child’s parents. The money is not lost or given up but there will be a tax and/or penalty assessed for the privilege of not using this money on college education. This possible penalty and tax however should NOT be a reason to turn away from a 529 plan and here’s why. The contributions made to the plan through the years are not what is taxed. It’s the investment earnings that will be taxed and those would have been taxed somehow along the way anyway, regardless of how the money was spent. At Flesher Financial we help clients every day figure out what the penalty cost would be of not using the money in a 529 plan. While there is cost, it’s generally not a high as people think. Also keep in mind that a 529 can be used for trade school or re-gifted to another family member should the designee choose not to attend a traditional college setting. There are provisions in place for those who save too much money as well (what a fantastic problem to have!). The bottom line? Money not used for college tuition is returned to its original owner.
4. It is instinctual as a parent to put your children’s’ needs ahead of your own. It may sound hard to believe but when it comes to saving money for the future that probably isn’t the best strategy. It is very important to have your own retirement plan in place prior to putting money away in any type of college savings plan. There are all different types of loans and scholarships available to help pay for college education but there is nothing of the sort available to fund retirement. If there is not enough money put away for college the money can be borrowed. If there is not enough money put away for retirement, it can be a very frightening experience.
5. Finally, the correct 529 plan to choose depends on what the tax rules are for the state you live in and the fees associated with that 529 plan. For example, at the time of this writing, New York state gives its tax payers a $10,000 per family income tax deduction on contributions to New York state 529 plans as long as the contribution is being made by a plan owner. Flesher Financial Services works with clients to weigh the costs and benefits associated with different plans and choose the one that is right for that family.