Are you a new parent or have you recently had another child and you’re starting to think more about how you can save for his/her future?
If so, you must have heard of the Qualified Tuition Program (QTP) or more popularly known as the 529 College Savings Program. If you Google search “how to save for my kids,” the first results that pop up are articles about 529 accounts.
On the surface, a 529 College Savings account may seem like a no-brainer option for your kids because of the tax benefits. The program not only allows you to pay for higher education expenses without incurring any capital gains or income tax but you may receive a tax deduction for the contribution depending on what state plan you own as well. However, once you peel back the layers, the program isn’t all that it appears. In fact, it may mislead you into how best to save for your child’s future.
To put it bluntly, the 529 College Savings Program is overrated. Here are two primary reasons why:
1. A 529 College Savings Program is an account, not a strategy.
Many financial advisors and articles will tell you what type of account to open but won’t necessarily advise you on why and how to actually plan for your children’s future. It is short-sighted to only plan for their college fund; this is the time to anticipate their overall future expenses and how it will affect your own financial future.
Did you know you could use money from a Roth IRA to pay the university directly without incurring any income tax or penalties?
It’s a matter of prioritization:Consider prioritizing your retirement savings first before putting money into a 529 account. If your son or daughter receives a full scholarship or decides not to attend college, you can sigh with relief that you invested into your IRA first and did not “waste” it in a 529 account instead. When you withdraw from a 529 account, the earnings portion will be taxed AND you will be penalized 10% on the amount you withdraw if it is not spent on qualified educational expenses.
With that being said it’s more strategic to contribute the allowed maximum each year into your Roth IRA (currently $5,500 max for 2017 per individual).Any remaining earmarked college savings can go into an investment account then a 529 account afterwards.
Kill two birds with one stone: If your child doesn’t use the funds for college, at least you will still have your Roth IRA and other retirement accounts funded.
Investing for your children’s future is not about picking the right account to invest money in; it’s more about how you diversify your contributions.
2. College tuition is not the only expense you need to plan for your kids’ future.
Through a 529 account, you can only use the funds for tuition, room and board, and other qualified expenses defined by the IRS. That means if your child needs a new laptop, car, or fund for off-campus college housing, you won’t be able to use money from a 529 account to pay for those common future expenses without a tax penalty, at least. The account is very restrictive on the type of college expenses you can apply money towards.
Common expenses that you may have to continue covering for your child in the future include medical insurance, auto insurance and maintenance, clothes, cell phone bill, groceries, fuel, utilities, school activity and club fees, and school supplies other than books. You cannot use money from your 529 account to pay for any of these without tax penalties. Instead, consider contributing to an investment account or high-interest savings account earmarked for these common future needs.
Planning for your children’s future can be challenging due to their unknown future decisions and plans. There are too many variables to consider to solely focus on putting away money for college. Instead, focus more on creating a flexible financial strategy that will allow you to meet your personal goals, such as retirement.
The best investment for your children’s future is spending time educating them early on in their lives about the value of money and, most importantly, educating them on how to be independent, self-sustaining individuals.