Should We Put $5K into a 529 Plan?
This article may contain references to some of our advertising partners. Should you click on these links, we may be compensated. For more about our advertising policies, read our full disclosure statement here.
Hello, Thriftaholics! As you probably know, Holly and I went to New Orleans last weekend for the nerd convention that we call FinCon. It was freakin’ AMAZING! Not only did we get to hang out with a bunch of our best friends from all around the internet, we actually learned a lot too.
I’m sure that Holly is going to give you a recap, so I don’t want to blow it. However, you can expect to see a few changes around here in the next several months – which includes seeing my ugly mug a lot more often. For those of you who know me, I’m excited to be back. For those that don’t, hold on because it can sometimes be a wild ride!
529 College Savings Plans
So, lately Holly and I have been discussing our two daughters’ 529 college savings plans. Since we started saving for college fairly early in our daughter’s lives, we have been able to sock away quite a bit of cash for each of them. In addition to making small monthly contributions, we’ve also been putting most of the money that they get as gifts into their 529 plans. As we all know, small amounts of savings can accumulate into big chunks of cash over time. While we’d love to be able to pay for both of our daughters’ educations in full, I decided to take a peek at a college savings calculator to see just how much that was going to run us. What I found nearly had me running for the toilet!
College is Going to Cost HOW MUCH?
I decided to bust out the “World’s Simplest College Savings Calculator” and the results blew me away. According to this completely non-biased tool – which I’m totally sure is not trying to sell me anything – projected 4-year college costs for my 5-year old daughter at a school currently priced at $25K/year are just over $200,000!!! Umm…WTF!
First of all, if college costs grow to be that outrageous, nobody is going to be able to afford to go. Second, it looks like it is community college and a part-time job for my little angels. Third, seriously, WTF!!!
Our Current Situation
At our current rate of savings, our girls will not have anywhere near that amount in their 529 plans. We do plan to use income from our rental houses to help pay for college, but that still won’t be nearly enough according to this calculator. After saving close to 40-50% of our income in retirement and savings, we are still going to have some money left over at the end of this year. I got to thinking that maybe we should think about putting a hefty lump sum into their 529 plans now and let that grow for a while- as we have done in previous years. The details:
- 529 plan savings will almost double.
- Our state gives a 20% tax credit (that is credit, not deduction) on the first $5K put into a 529 plan each year.
- We have a little extra, so why not?
- You can only use the money in a 529 plan for educational purposes. What happens if they decide not to go to college? (Not on my watch girls!)
- I’m kinda greedy.
- We clearly aren’t going to be able to pay 100% for college, so is that money better spent elsewhere?
Since we can no longer proceed blissfully unaware that we aren’t saving enough, we now have a dilemma. Do we tuck 5K away for the rest of their early years, taking full advantage of the 20% tax credit? (That’s $1,000 cold cash back, yo!) Do we put that money into a mutual fund, ear marked for their college which gives us more flexibility but also more taxes? Or, do we simply sock that money away into our own savings, possibly moving from a traditional bank to a credit union with a better interest rate? Ugh. Don’t get me wrong, this is a great decision to have to make, but sometimes ignorance truly is bliss.
What do you guys think? Let us know by taking the poll and leaving a comment below!
Disclaimer: Comments, responses, and other user-generated content is not provided or commissioned by this site or our advertisers. Responses have not been reviewed, approved or otherwise endorsed by this website or our advertisers. It is not the responsibility of our advertisers or this website to ensure that all comments and/or questions are answered. Club Thrifty has partnered with CardRatings for our coverage of credit card products. Club Thrifty and CardRatings may receive a commission from card issuers.
Greg the first question I would ask is are you maxing out both of your SEP ira, 401k and Roth iRA. If you aren’t I would recommend you do not put it in the 529. The reason is that retirement assets do not count toward parental contribution on the FAFSA. You could have a million dollars i and it won’t coun
Got cut off. Having assets in a 529 will reduce your children’s financial aid award as it is counted as an asset. That could end up costing you thousands.
You can fund a college education from a Roth ira tax free without the early withdrawal penalty as long as your Roth has been opened for five years and you utilize it for college expenses. There’s a form you will need to fill out, Google this method. Using this method you will qualify for a lot more financial aid and grants.
529 Plans owned by the student
Beginning with the 2009-2010 school year, student- and UGMA/UTMA-owned 529 accounts are to be reported as parental assets, if the student files the FAFSA as a dependent and has to include parent assets and income. This treatment confers a financial aid benefit as the parental rate of 5.64% is considerably less prejudicial than the 20% rate on non-529 assets owned by the student.
So it is considered a parental asset. So it would count just as much as your ROTH idea and they get a 20% credit. I don’t know too many investments that give a 20% return right away.
My bad… you are correct a ROTH doesn’t count. But they would still be ahead (in my opinion) because they are get 20% back on their state taxes as a refundable credit.
It is also fairly difficult to not owe taxes in the state they live in. I should know I live in the same damn state.
Our 529s are listed as parental assets!
As long as you are already maxing out your retirement savings and you have the extra money, I think I’d be putting money in the 529 plans. You can transfer the account into the name of a different family member if one child decides not to go. Although I think if you and Holly are both college grads, the odds favor your children attending college as well.
I am actually not worried at all about our kids not going to college. They will or they won’t- I’ll stress about that when they get older.
Are you maxing out ALL of your other tax advantaged savings first? 529s sound like a nice thing, and I think they can be appropriate in a lot of cases, but way too many people consider their kids potential education above their retirement.
The other thing about 529s is that they count as part of your “expected family contribution” when calculating financial aid eligibility. Your home equity and retirement (even roths, which you can use pre-retirement) do not count as part of the EFC.
If you want your children to qualify for financial aid, it’s not too early to start planning and moving assets around to maximize their chances.
Yes, we are maxing out regular retirement accounts and ROTH IRAs.
I actually don’t think it’s a good idea to move assets around with the hope of getting financial aid. Our kids are 3 and 5- chances are good that rules will change at least once before our kids are ready for college. I would never make any big financial moves now for the sole purpose of hoping to get financial aid.
I’m also doubtful we will get any meaningful financial aid anyway. Our home and two rental homes will be paid off in the next 12 years and it looks like our income will be too high if things continue the way they are.
The home doesn’t count for financial aid calculations for a lot of schools (though not all schools).
Um, wow. I have no advice because we haven’t even started saving yet, but I’ve been living under the hope that we can afford just about anything once our student loans are paid off… But maybe not my daughters’ college education.
I think college is going to look a whole lot different by the time your kids go. There are going to be more virtual and on line universities, Students will meet for study sessions and exams. I see college being a whole lot more affordable because of technology. Like you said, if it keeps going like it is, hardly anyone is going to be able to afford to go!
I’m leaning more and more towards the traditional college alternatives- community college, part time work, practical skill training. I saw some crazy stat that those with Associates degrees in STEM fields see a much higher return on investment than those with Bachelors degrees in non-STEM fields. It seems like the major and skills are more important these days than the school.
About half of my writing is about higher education- both online and on-campus- and you are spot on. Many people don’t consider the ROI of a particular degree and it is generally to their detriment. My kids are 3 and 5 so we aren’t really talking college majors yet, BUT I do plan to guide them once we get to that point. The fancy degree just isn’t paying off the way it once did.
I agree with this 100%! Things have changed since my husband and I went to college. Now, the college doesn’t matter, but the major and degree matter. People going to what was considered a crappy community college when I headed off to an ultra-expensive private university are making three times as much as I am if they got into the right field.
It isn’t clear though that it is the actual learning from the major vs the fact that these more lucrative majors flunk out students who won’t be good workers and attract people who are smart and hardworking. The major choice may just be correlated with ability rather than the cause of higher income.
That’s a good question and a great situation to be in to be in with having the extra money. With you guys maxing things out and already saving nearly half, if not more, of your income I’d be inclined to go with the 529 route. The nice thing about doing it now is that it gets you 15ish years to grow that money which should help some. The assets can also be transferred to another child if one doesn’t go to college so I wouldn’t be too concerned about one of them not going. We’ve been putting away money for our kids, but need to get serious and open 529s by the end of the year. We currently have UGMA’s for them but that’s just not going to be enough.
As long as you aren’t giving up saving in other tax preferred savings vehicles and that you have good investment choices in your 529 plan for this, it sounds like a good plan. All around, a good problem to have!
Hey Greg! Well considering the options, I would still go on trucking with contributing the the 529s just for that 20% tax credit. Sure there are no guarantees that both girls will end up in college for a formal degree but they may want to study a trade or skill such as being a nurse etc…and those programs would still qualify. I don’t think you can go wrong with that.
20% tax credit = awesome! It’s only 10% in my state, but still a nice little incentive.
When we were saving for our son’s college, 529 plans didn’t exist so I have no experience with them. I would suggest that you first be comfortable with your state’s family of funds that is used and check out any fees etc. We put some of our son’s college money into a UGM account but most of it was held in our names in a mutual fund and CDs (good interest rate back then) so if something unforeseen came up and he didn’t attend college, we would still have the money in our names.
I struggle with this, too. For years, we’ve auto-transferred $100/month to each of our 8 and 10 year old sons’ 529s. It will by no means be enough and we could afford to put more in (we max out our 401ks and are very fortunate to make more than the Roth limits), but we’ve chosen to use excess cash to pay down principal on our mortgage to hopefully pay it off in the next 12 months. The ultimate question for us is whether paying off a 3-4% mortgage and being debt free makes up for the lost time we could have spent investing more toward college.
Since you all are maxing out your retirement and still have money left over, I think it’s a no brainer to stuff that money away in your kids 529 plans. I’m all about keeping as much money away from Uncle Sam as legally possible. That tax credit you are receiving is more than enough reason to hook up the 529’s ASAP.
Great problem to have an extra 5K. 🙂 I think if you have met you other retirement goals I’d drop it in the 529.
Given that you’re maxing out your retirement (I assume that’s including the SEPA), then yes, put the money into a 529. I can’t see any reason not to given that not only do you get the tax advantage on the earnings AND you get a break on your state income taxes. It seems like a no-brainer.
Now, I also want to point out that it is extremely unlikely that you’ll have to pay the full cost of a four year private school for your kids. Even if you’re in the upper-middle-class bracket they’re likely to get some financial aid at some subset of the schools they get into. The simple college calculator doesn’t take that into account unless you tell it. You should also try a few of the online calculators from various universities that give you more information about financial aid. Of course, it’s important for your kids to get good grades and stuff in high school.
I know that I say we’re expecting to pay full freight for our kids, but that’s because I’m also expecting us to be making a LOT more than we’re making right now by the time our kids are in college… as in, I expect at least one of us to be making 200K/year with promotions and job changes and so on (neither of us is anywhere near that right now, but if we keep working hard and are willing to move, those numbers aren’t impossible in our professions). If that doesn’t happen then we’ll stop contributing to the 529 cold turkey once we get closer to the deadline. But it’s better to contribute early when you can than to wait until later when it doesn’t matter if you get tax advantages because you’re not going to be keeping the money in the account long enough to appreciate.
5K now isn’t going to make or break your ability to get financial aid or pay for their college. It will help you pay for some of their college and you’ll really appreciate it when the time comes.
Yes, I maxed out my SEP IRA last year. I haven’t yet this year because I contribute monthly and I generally top it off once I figure out exactly how much I made. Last year I almost put too much in and we were super close to paying a penalty. I am being conservative this year and will top it off at the very end to avoid that situation!
We haven’t hit the 5K mark yet but we have been contributing every month then a lump sum at the end of this year. I am leaning toward topping off the 5k from now on, simply because I cannot think of a good reason not to.
In your situation, I’d put the money in the 529. If the girls decide to be the next Beyonces and skip college, then you take the penalty and get a nice chunk of change for yourself.
I’ve been thinking about that recently too…though our son is only 14 months! But we’re contributing a measly $50 a month plus some gifts he got early on. I think I’d consider looking into Charles’ method though…are you guys maxing out your Roth? If not…that might be a better choice. I think my wife and I should do that as well before we consider increasing the 529 plan. Can you explain the 20% tax deduction. I only get a deduction for our state which comes to like 6% or something like that.
Yes! We max out Roth IRAs!
The state of Indiana offers a unique 20% tax credit on the first 5K we contribute in any given year. So we basically get back $1,000 at tax time for the first 5K we put in- in instant 20% rebate.
Wow, that’s pretty awesome! Since you already max out your retirement…sure why not put in $5k since you’re getting $1k back.
Wait! How do you get a 20% tax credit? We got virtually nothing back at all for these 529 plans. We are in PA.
It’s a tax credit for Indiana residents!!!!! =/
My husband and I are about to have a baby and education costs have been something we’ve already started discussing. The tax benefits of the 529 plan sounds good and given a high chance your girls will be using the fund in the future (no need to worry about penalties), I would say go for it.
A bit off-topic but I was curious to know whether you have considered what effect it may have on your girls, knowing that this fund exists for their college expenses? My husband and I both wonder if it can perhaps lead to complacency in children. I myself was motivated to do very well in school to qualify for financial aid and to pursue a highly in-demand STEM degree since I knew my family wouldn’t be able to afford the university I wanted to attend. My fear is that our child will simply float through college, with no appreciation for the education because it was completely paid for by us.
Oddly, the research on pre-paid college (see: Kalamazoo promise etc.) seems to show that having pre-paid college available leads to higher grades and test scores in K-12 and more kids going to college. The research isn’t complete yet, but that’s what early research is showing.
I wasn’t aware of the research being done. Thank you for bringing it to my attention!
Regarding the Kalamazoo promise (I just looked it up), since this is in a relatively high poverty area, I wonder if the motivation of students are coming from the fact that they now have an opportunity for college where before they may have thought it was impossible. The results may be different with middle-class or affluent students, who grow up viewing higher education as always a possibility.
Well, once you get into upper-middle class and affluent students, there’s all sorts of class issues about what the purpose of college is. For example, the idea that college is there to get you a highly paid job or that you should major in STEM so that you’re guaranteed employment– affluent kids aren’t generally taught to think that way. College is a coming of age experience. It’s where you find yourself. Major in what you love and the money will follow. People get jobs that have nothing to do with their college major. To quote South Park, “There’s a time and a place for everything, and that is college.” When you come from affluent circumstances you have the luxury of not having to take college seriously. http://notofgeneralinterest.blogspot.com/2014/09/was-there-ever-time-of-idealism-in.html talks about how the perceived change in these sentiments is probably because of the diminishing middle class.
Honestly, if you haven’t instilled a respect and/or love for learning prior to your kid getting into college, how much of the bill they have to foot compared to what you foot is probably not going to change much. Knowing that your parents are sacrificing for your college probably instills more of that respect than signing promissory notes for loans that you don’t really understand and won’t see until later anyway.
I actually hate the “I’m not saving for college because I don’t want my kids to expect it” argument. What a terrible reason to not save for college.
I don’t spoil my kids and they are actually really appreciative of what they have. I brought them into this world- I’m not going to leave them to fend for themselves once they leave the nest.
I say open a Roth for each of them. If one of them is super smart, or super athletic, and gets some sort of scholarship, they can use the money for something else without penalty. Withdrawals for education are always free and if they don’t need it, they can use it for a home purchase or have a serious head start on a tax free retirement.
Given that they’re not child models and are well under the age of even 14, it’s really unlikely that they have the employment required to open Roths.
I think she meant 529, lol. They both have one already with quite a bit of money in it!
But you can’t use a 529 to buy a house without penalty.
The 529 sounds like the best path for you guys in your state, the issue is if they don’t end up going to college then the money has to be used for that purpose or it will penalized. 1,000K back is a good benefit. Getting real life experience has more weight than a degree I’ve noticed.
Greg, it’s great that you’re focused on saving for college. Yes, that price calculator figure of $200,000 gave you sticker shock, but remember that few families pay the “sticker price” of college. Every dollar you save is a dollar that won’t have to be borrowed. One option you didn’t discuss is prepaid tuition 529 plans. I am president of one such plan, Private College 529 Plan, which is owned by 277 private colleges and universities across the country. It was established in the same law as state plans. The money you contribute pays for tomorrow’s tuition at today’s prices. The colleges guarantee that. It’s one more option to consider.
I don’t understand American finances at all but the basic math to me sounds like you’re only ‘losing’ out on a $4,000 investment…given you’ll get the 1k back why not? 2k per child, I’d do it up.
I was sold at “20% tax credit.” I don’t have kids, but if I did I would be taking full advantage of those tax savings. Also, being married to someone whose family made enough to help them out with college but didn’t give her a dime, I know how much every dollar a parent contributes can help students post-grad. I’m shooting to pay about 50% of my kid’s college education. If I have more money to contribute, great! If not, 50% is a generous amount imo.