December, with all its merry festivity, is naturally the month we contribute to our daughters’ college funds. Ah yes, just what every four-year-old and 22-month-old want for Christmas: well-funded 529 savings plans.
Save On What Doesn’t Matter: Spend On What Does
This is my approach to spending money on our kids. So, yes, they both have hand-me-down cribs and a dresser we found on the side of the road, and used clothes, and toys from yard sales. And yes, they have snow pants from thrift stores and coats that don’t match; but to me, none of that matters.
Buying used stuff for your kids isn’t going to save enough money to put them through college, but it will save something and something is better than nothing.
Focusing on longterm goals–for yourself, for your kids–is an excellent way to avoid meaningless short-term spending.
Here are a few posts on how we save money during the early years of parenting:
- How I Saved Tons Of Money During My Baby’s First Year
- How to Thrift Like a Rockstar: Plan Ahead, Buy Ahead and Focus on Depreciation
- How To Find Anything and Everything Used: A Compendium Of Frugal Treasure Hunting
- Fighting Back Against The Baby Industrial Complex
What’s a 529 Plan?
Try to contain your excitement. I’ve received A LOT of questions about 529 plans over the years, so to the people who’ve asked those questions: your time is now. 529s are college savings plans.
There’s a lot of confusion about 529s and for good reason: they are administered by the states and they vary from state to state.
Adding to the confusion is the fact that you don’t have to use the 529 offered by your state. Many people do use the 529 offered by their state because a lot of states provide a tax benefit for in-state contributors. In other words, in some states there’s a state tax advantage if you contribute to your state’s 529.
Furthermore, some states have residency requirements regarding their 529 plan, so you’ll have to check into your state’s rules. NerdWallet has this nifty overview of what each state does (and does not) offer when it comes to 529s.
If you have kids and if you think they might go to college and if you have some money to put towards saving for their higher education, a 529 plan might make sense for you. I rarely discuss 529s (or advise people to use them) because it really, really, really (we’re talking really) depends on your personal tax circumstances, the state you live in, and your future/projected/potential plans for your kiddos.
A few advantages of 529s:
- The state tax advantage (in some states). Note that your kid doesn’t have to go to a college in your state, unless you’re looking into a pre-paid 529 plan (which means you lock in today’s tuition rates at a specified state school).
- Other family members (or friends!) can make contributions to your kid’s 529, which is an easy way for them to help you save for college over the years.
- Arguably the most significant advantage is that the money in a 529 grows tax-free and isn’t subject to federal income taxes when it’s withdrawn for educational expenses. This is what makes a 529 a better college savings vehicle than, say, a regular taxable brokerage account.
Some downsides of 529s:
- Depending on your state–and your state tax burden–a 529 might not be all that advantageous from a state tax perspective.
- The money is restricted for use on higher education and related items (room, board, tuition, computers, etc).
- You can withdraw the funds for other purposes, but you’ll pay a fine (see below).
What if my kid doesn’t end up going to college? Or gets scholarship?
You have a few options in these scenarios:
- You can withdraw money for something other than educational expenses; however, the withdrawal, “will be subject to state and federal income taxes and an additional 10% federal tax penalty on earnings” (source: SEC).
- You can change the beneficiary of the account. So if one of your children isn’t going to use their 529, you can transfer their 529 to another of your children.
- If a kid receives a scholarship, you’re allowed to withdraw the amount of the scholarship from their 529 without penalty (although you will have to pay taxes on any gains in the account). Alternately, you could keep the money in their 529 as it can be used later for graduate school.
When should I open a 529 for my kid?
Ideally as early as possible. Since 529s are invested in the stock market, they need time to grow. The longer they’re invested, the more likely they are to grow. If you start a 529 when your child is born, you’ll have 18 years of growth in their account.
This is one argument for starting a 529 when a baby is born, even if you can’t contribute very much money at the outset. In some states, there’s no minimum contribution amount and in other states, it’s as low as $10. And if you’re looking for a baby shower gift that’ll keep on giving–a contribution to a 529 account is a fabulous way to go!
Fun fact: they’re called 529s because they’re governed by Section 529 of the Internal Revenue Code. If that’s not cocktail party fodder, I don’t know what is.
Put Your Own Oxygen Mask On First
While saving for your kids’ college education is a nice thing to do, it shouldn’t come at the expense of your retirement savings. Your kid can take out loans for college; you cannot take out loans for retirement. A 529–or any other college savings account–should come second to retirement savings. Think of it this way: it’ll be better for your kids to take out student loans than to be financially responsible for you in your old age. Put your own oxygen mask on first, fund your retirement accounts, and then look into saving for college.
A Few Good Resources on 529s:
- The US Securities and Exchange Commission: An Introduction to 529 Plans
- The Internal Revenue Service: IRS offers guidance on recent 529 education savings plan changes
- The US Securities and Exchange Commission: 10 Questions to Consider Before Opening a 529 Account
- NerdWallet: 529 Plan Rules
This has been your hopefully helpful, hopefully not-too-confusing, not terribly boring primer on 529 college savings plans.