How am I ever going to send my kids to college?
The cost of college is out of control. I have three kids and
I am like screw college, go get a job or better yet go start
a business and you could live at home for free. Hopefully,
by the time my 11 year old goes to college things will be
different, but if they are not then they better be different
by the time my 1 year old goes. When my first son was
born I was laser-focused on saving for his college
education. I was actually saving for it before he was
born. As soon as I received his social security number
I went online and opened the NY 529 plan with Vanguard.
I still believe that a 529 is the best way to save for a child's education for most people. Once I learned more about real estate investing I ended up buying a rental property with a 15 year mortgage that will be paid off by the time my little one goes to school, but that is not nearly as easy as just starting a 529 plan.
What is a 529 Plan?
A 529 plan is a college savings plan with unique tax benefits to encourage saving for a child's education. 529 plans are sponsored by the individual states. So for example, New York has its own plan, Connecticut has its own plan, Florida has its own plan an so on and so on. One important point to remember is you do not have to open the plan offered by the state you live in. You can live in Florida and open up the NY plan. The reason you might want to stick with your state's plan is if you will receive a state income tax deduction for contributions (like you would if you live in NY and open the NY 529 plan). With the recent tax overhaul, 529 plans can now also be used for private K-12 school tuition for up to $10,000 per year. Pretty cool. Let's take a look at some faq's when it comes to 529 plans:
What if my child does not go to college?
You can change the beneficiary to another qualifying family member. (Brother or sister, grandchild, yourself)
You can take a non-qualified withdrawal and pay a 10% penalty and federal income tax ONLY ON THE GAINS. If you received a state income tax deduction it may be subject to recapture.
Use the funds for a vocational school, community college or another qualifying institution.
What can I pay for with a 529?
College Tuition and Fees
Up to $10,000 K-12 Tuition
College Books and Supplies
College computers and equip.
College room and board
College off-campus housing
What if something happens and I need to use the money for something else?
If you need to take a non-qualified withdrawal you will owe a 10% penalty and federal income tax ONLY ON THE GAINS. If you received a state income tax deduction it may be subject to recapture.
What happens if my kid gets a scholarship
1. You can withdraw the same dollar amount of the scholarship and not have to pay the 10% IRS penalty. You will still have to pay income tax on the earnings portion of the withdrawal.
2. You can use the funds for other college expenses like room and board, books, supplies, a computer, or hold onto the funds for grad school.
3. You can change the beneficiary to another qualifying family member.(Brother or sister, grandchild, yourself and many more)
What are the tax benefits?
Qualified withdrawals are federal income tax-free meaning you will pay no tax when withdrawing the funds
Earnings grow in the plan tax-free.
You can get a state income tax deduction on contributions (up to limit) depending on your state tax laws.
What are my investment options?
Depending on your state's plan, you will have a menu of Mutual Fund or ETF options. You will have the option of putting together your own portfolio or using an age-based portfolio that gradually gets more conservative as your child approaches college. Personally, I use the age-based portfolio for my children. Remeber, these are stock market-based investments. You want to make sure you are comfortable with the amount of risk you will be taking in these accounts.
Things You Need to Know
Do Not buy a 529 plan through your financial advisor or through a bank! Most states offer a "Direct Plan" and an "Advisor Plan". The fees are outrageous when purchased through an "Advisor Sold Plan". Your advisor should be willing to help you with the allocations even if you set up a direct plan on your own. If they will not help you then you have the wrong advisor.
If your state has no income tax, chances are you will end up with an out of state plan. Of course, if your state offers a great plan this will not be true, but just make sure you research all the plans available. If your state offers a state tax deduction then that is usually going to be the best option.
The expense ratio is very important. Do not choose funds that have high expense ratios. Many plans offer low-cost index funds which are a great way to go.
529 Plans are not a low-risk way to save for college. Understand that the balance will fluctuate depending on how it is invested. Make sure to get more conservative as your child approaches college.