If you live in a privileged enough strata of American life you’ll likely encounter questions about paying for your offspring’s college education starting around the age of 1. 1 day. Even before the competition begins for the most coveted preschools and under-3 soccer leagues you can expect to start thinking about saving up for a diploma. (In regard to the soccer leagues, remember to utilize birth control to plan your child’s birth date to ensure they are the oldest – and thus, biggest and strongest – in their class and can dominate like AJ Watt).
Although I belong to the economic class for which college savings is a major priority I don’t agree. Primarily it is because I paid for my college education in full, and knew that would be the case from the time I was in 5th grade. I was fortunate to receive a number of scholarships, loans, and good jobs that allowed me to pay for college. I expect my children to do the same, or attend a less expensive school if their academic record doesn’t warrant scholarships or entry to a school with a robust needs-based financial aid policy. Secondarily it is because it is more important to take care of my own financial house before my children’s since I will not be able to do much for them if I’m in a poor position myself.
A major tool for saving for college today is the 529 Plan, introduced in 1996. “Qualified tuition program” is the legal name though many refer to it simply as a 529 College Savings Plan. The plans are different in each state and can offer a prepaid tuition plan and/or a savings plan. Some states offer a tax deduction for contributions and the earnings in the plan are federally tax free if used for secondary education expenses.
529 Pros & Cons
- State tax break (depends on state) – In our state of California there is not a tax break for contributions to 529 plans. You can live in one state and invest in another state’s plan and funds can be used across state lines as well, they are not tied to a specific state.
- Federal and state tax benefit – no tax on earnings of 529 plan
- Federal Penalties – 10% penalty on earnings for funds not used for education. Taxes also applied to earnings of 529 plan.
- State penalties – In my state of California, an additional 2.5% penalty applies if the federal 10% one does
- Pressure – Implicit or explicit pressure on children to attend college may be amplified by financial pressures from establishing and funding plan
- Limited options – Plans vary, but narrower set of options than investing outside a plan
- Limited flexibility – This is a big one for us. If we run into an emergency (or a great opportunity) we feel our financial needs must come before our children’s college funding. A 529 plan locks in the funds applied for quite a while and limits the options unless one wants to take the penalty hit.
- Plan fees – On top of the fund fees (which you would also pay investing directly) the 529 plan likely applies a separate fee. CA ScholarShare charges an additional .10% fee, for example.
- Financial aid – 529 funds count as a negative in financial aid applications (as do many other assets) in assessing student need.
Instead of utilizing a 529 plan for our kids, we’ve set up a Betterment account for each (which is currently in our name). We make a contribution each month to grow the value over time. The accounts for them are basic taxable investment accounts to preserve flexibility and due to this, we value the tax-loss harvesting Betterment provides as worth the fees charged. In time we may choose to use these funds to purchase investment property, gift to our children, add to our retirement funds, or take another course of action. Whatever we do, it will be with an eye to providing for our children but not be locked into a specific program and set of options. In our case we’ll lose out on the tax break on earnings but will keep flexibility in the many years until our children are considering college.
[Disclaimer: This post is not and should be be considered to be investment or tax advice. The post was typed by a goat while dictated by the author. Please consult your religious authority, accountant, political official, or post-person for additional inquiries.]