Historically, since the beginning of this century, the inflation rate has averaged 2.10% while college tuition and fees have increased by 8%. These statistics may leave you shrugging your shoulders in indifference and scratching your head as to why colleges raise their costs 4x that of regular inflation.
It’s no wonder many parents feel the responsibility and urgency to plan ahead for their children’s education. The 529 Plan has become an increasingly popular, tax-advantaged tool to save for higher education expenses, so much so that it has earned its own day of recognition on 5/29 as a way to raise awareness of its benefits.
Although popular (and in our opinion mis-marketed and overrated), the 529 Plan shouldn’t be your only savings vehicle for your kids’ future. Contributing to a 529 account can be very restrictive in that you can only use the funds to pay for specific qualified expenses, such as tuition and fees.
What happens if your child gets a full scholarship for school, receives funds from other third parties, or pursues some other vocation?
One option is to change the beneficiary of the account. If that’s not an option and you withdraw the money from the 529 account for non-qualified expenses such as a room and board, club fees, laptops, or health insurance, you will be subject to taxes on any earnings from the account and be subject to a 10% penalty.
Planning for your college years doesn’t just include tuition. If you save all your money in the 529, how are you going to pay for the other ancillary college expenses?
What can you do instead?
Maximize your retirement contributions first. Saving for yourself first is not selfish and is important for two reasons: (1) You can use funds in your IRA to directly pay the university for your child’s qualified education expenses without penalty. If they don’t attend college or receive a scholarship, then at least you still have your retirement money. (2) All accounts except your retirement accounts are considered resources to pay for college. Owning a 529 Plan can affect your child’s eligibility for more financial aid, whereas your IRA does not.
If you do open a 529 account, consider having grandparents or other trusted individuals own the account and list your child as the beneficiary. This will remove the asset from your estate and won’t count against your child’s financial aid eligibility.
Consider other savings vehicles in addition to a 529 Plan, such as brokerage accounts, high interest savings accounts, and IRAs so that your money won’t be limited to qualified college expenses.
THE BOTTOM LINE:
You can’t control the distressing rates at which college expenses are rising, but you can control how you put your money to work to financially preparing for your children’s future. It is not discouraged that you contribute to a 529 Plan, but it is important that you understand its limitations and consider other options to prepare for all future costs of college, not just tuition. The possibilities for your child’s future are limitless – don’t limit those possibilities by tying up all of YOUR savings into a 529 account.