I get it. Saving for your kids’ college is a scary thing to even think about. You may be living paycheck to paycheck, you may have debt, and you may be completely overwhelmed to begin to even comprehend how in the hell you’re possibly going to save another dollar for your kid’s college.
Here’s the deal – I get it and I get you.
I remember living paycheck to paycheck, I remember having $52k in consumer debt, and I remember feeling hopeless.
But, we made it out. We chose to live our life on our terms instead of the bank’s. It was never easy, we had an uphill battle, but most importantly we had hope.
Hope kept us motivated. We began to see hope for our future, for our retirement, and for our kids.
The same hope that pushed us through towards debt freedom has also helped us stay disciplined in all areas of our financial plan.
Including saving for our kids’ college.
Why Plan for College Now?
If you think the cost for college tuition is out of control, then you’ve been paying attention. From 1914 – 2016, the average inflation rate for consumer pricing in the United States has averaged 3.3%. The average inflation rate for tuition looking back to 1958 has fluctuated between 6% – 9%!
Here is a simple way to put it:
- Tuition will double every 9 years.
- A baby born right now will pay three times the tuition rate of today.
With that said, here is what you can do about it.
What is a 529 Plan?
Simply put, a 529 plan is an education savings plan to help pay for future costs of college. It was created in 1996 and was named after the location in the Internal Revenue Code: Section 529.
The IRS is brilliant when coming up with their naming system, right?
Every 529 Plan is actually sponsored by a state in the U.S. That state is responsible for the assets inside the funds and is also responsible for who is managing them.
Common 529 Myth
Many people are under the impression that you can only save in the 529 plan for the state you live in, or you can only go to college inside the state of the plan you are saving in.
This is absolutely 100% false.
Here’s an example of how it works:
If I live in Arizona, I can save in Virginia’s 529 plan, and I can attend a college in New Hampshire.
That’s it – It’s really that simple.
What are the Advantages of a 529?
The main advantage of a 529 plan are the tax savings.
You send after tax dollars to the 529 savings plan of your choice
This is the money that lands in your checking account after you have paid taxes.
The money inside the 529 grows tax-free inside stocks, bonds, mutual funds, etc. Normally, you would incur annual income taxes and capital gains tax on the withdrawal if outside of a 529.
The money can later be withdrawn tax-free to pay for qualified educational expenses
But Wait, There’s More…
Most states will offer a state tax deduction for contributing to their own state’s 529 plan, however there are currently six states that offer a tax deduction when you contribute to any state’s 529 plan (Arizona, Kansas, Maine, Missouri, Montana, and Pennsylvania)
In my home state of Arizona, I can invest into a Virginia 529 plan and then deduct up to $4,000 (married filing jointly) from my state income taxes every year.
It gets even better…
In addition, contributions made inside any 529 plan are also eligible for the annual gift-tax exclusion rule.
What this means is a grandparent can deposit up to $14,000 (or $28,000 married filing jointly) each year into their grandchild’s 529 plan and they will not inherit any gift tax whatsoever.
Hey Grandma, instead of buying the grandkids socks this Christmas, wouldn’t you rather drop a few dollar bills into their 529?
You Remain in Control
Although you will have to name a beneficiary for the 529 plan, you still remain in full control of the assets inside the plan. This means when your child turns 18, they don’t have the legal decision making powers to decide on what happens with the money.
This gives the parent the ability to help their know-it-all teenager make the best possible decision with the money you have worked so hard to save for.
An additional benefit is you can withdraw the contributions you have made to the 529 plan at any time without a penalty. However, if you withdraw the earnings portion that is not covered under a qualified educational expense, you will have to pay the income tax and incur an additional 10% penalty.
Bottom line: Please don’t do this.
Who Can Contribute to a 529?
Anyone can contribute to a 529 Plan.
How much can I contribute?
To put it as simple as possible: A ridiculous amount of money.
There are no income limitations set for saving into a 529 plan (unlike a ROTH IRA), however there are lifetime deposit limits of up to $400,000.
In addition, a grandparent for example can contribute between $14,000 and $70,000 one time if they only do it once over a 5-year period ($14,000 x 5 years = $70,000).
Note: Avoiding gift tax and depositing money into a 529 plan has become increasingly popular among estate planners who are looking to avoid estate tax while still providing a valuable gift inside their family tree.
What are Qualified Educational Expenses?
- Qualified Educational Expenses
- Equipment required for course enrollment
- Computers (if required by school or program)
- Room and Board
Non-Qualified Educational Expenses
- Transportation Costs
- Student Loan Repayments
- Beer Pong
- Fraternity/Sorority Dues
- Tickets to the Football Game
Direct vs Advisor Sold 529 Plan?
You have the option to do-it-yourself, or you can have an advisor help you.
A Direct Sponsored Plan
This means you are fully in charge. You decide on the stocks, bonds, mutual funds, etc. If you like to be in full control and you’re comfortable doing this, then the advantage here is you’re not paying an advisor fee to help you.
An Advisor Sponsored Plan
This means you are asking for help. This plan can only be invested into through a financial advisor, and there is a fee associated with having professional help.
Will it Affect My Child’s Ability to Receive Financial Aid?
Yes, but it’s very minimal.
When you go to apply for financial aid, you will have to fill out a FAFSA (Free Application for Federal Student Aid).
The FAFSA will take a look at the student’s financial situation and their current assets to determine if they are eligible for financial aid.
However, since the 529 plan is actually owned by the parents and not the student, the educational institute will look at something else called the Expected Family Contribution (EFC).
In a nutshell, the higher the EFC, the less financial aid your child is going to receive.
The good news here is the school is only allowed to use 5.64% of the EFC to calculate eligibility requirements. When you compare this amount to the 20% they are allowed to use for the student’s own assets, I’ll take the 5.64% via a parent-owned 529 plan over the 20% calculation all day long.
Remember, the higher the EFC the lower amount of financial aid.
What if my Child Doesn’t Use or Need the 529?
There are many myths out there that if your child doesn’t attend college, or if he or she gets a scholarship, you will lose all that money inside the 529 Plan.
Truth: You will NEVER lose the money inside the 529 plan.
If your child receives a scholarship, chooses not to go to college, becomes disabled, or the unthinkable happens – your child dies, there are four options available to you.
You can redirect the 529 to a sibling, another qualified family member, or even a future grandchild.
You can save the money inside the 529 for a future graduate school for your child.
You can simply withdraw the money and pay the 10% penalty. The penalty is however waived if the reason is due to a scholarship, U.S. military academy, or if your child was disabled or deceased.
You can go back to school and use it for your own educational expenses.
Make sure to understand that the beneficiary who you initially set up the 529 for can be changed at any time.
What Does Money Peach Recommend for 529 Plans?
I have two kids under the age of 7 years old and they each have an Advisor Sponsored 529 plan because I am willing to pay the advisor fee if it possibly means a higher return on investment. This is just me, but in my opinion I feel much more comfortable having a professional help in their area of their expertise than I do playing weekend-stock-picker with my kids’ college savings.
With that said, if I were to invest in a Direct Sold Plan, I would look at saving inside target date funds. These funds are based on the expected start date of college for your child. The funds start out aggressive for younger children and gradually become more conservative as your child approaches the age where he or she will begin their higher education.
If they get a Scholarship…
Both of my kids are going to college because we as parents talk about it as if this is the only option available to them 🙂 With that said, if any of our kids get a scholarship and no longer have to use the 529 plan to pay for college, they will be getting a pretty nice reward.
Someday Grandma and Grandpa will be paying for grandkids to go to college via that same 529 plan 🙂
How Much Should I Be Saving Right Now?
As I said earlier, the cost of college is so incredibly expensive and it continues to rise at an average of 6% – 9% every year. Therefore, you are going to most likely be shocked when you see how much it is going to cost your child (at any age) to attend college.
You can get a good idea with this simple calculator from SavingsForCollege.com
A good rule of thumb is to simply do the best you can. Saving for college comes after your emergency fund, after you debt snowball, and after retirement savings in your financial plan. Contrary to what you may hear or see in popular culture, no one is entitled to go to college. Period.
But, if you’re like me and want more of a black and white answer, then here are the numbers I recommend for saving for your kid’s college:
1. Choose a school or a couple of schools that are within the amount you’re willing to help your child financially. There is a large difference between Duke University and a 2-year community college followed by a 2-year in-state University
2. Take today’s tuition and add it into the Savings For College Tuition Calculator
3. Do your best to save at least a third of the total cost for tuition into your child’s 529 plan
4. Next, help your child apply for every scholarship and grant on the planet prior to attending college to cover another third of the total cost of tuition
5. Lastly, tell your child they are on the hook for the last third of tuition by becoming an adult and getting a job while going to school. A college graduate who works through college to help pay for tuition is much more employable than a professional student who maintained a 4.0 with zero skills beyond the classroom
Show Them the Money
If you’re able to save anything at all inside a 529 plan, I want you to show your child the money. I want them to see over a long period of time how much mom and dad were willing to sacrifice to send junior to college.
Furthermore, I want them to see how focused you are on them attending college, so that it just becomes part of their daily life, and the idea of attending college becomes as normal as bathing once a day….I hope.
Sadly, there doesn’t seem to be an end in sight with the incredible rise in tuition costs each and every year. Therefore, it is going to up to you to not only teach your children how to become smart with their own money, but to also provide them with any help possible so they can avoid student loans at all costs.
The 529 plan is the best possible option to do this. It’s the only thing we use, and therefore it is the only thing I will recommend.
Leave me a comment below and I will not only get back to you, but I will follow up with you via email. I want to make sure you fully understand all of this before you take the next step towards saving for your kid’s future.
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This money stuff isn’t taught anywhere and it needs to be on the minds of people just like you. What would the world be like if we didn’t have debt payments each month? How would people feel if they no longer had the stress about money? How much more fun could we have if money was no longer the #1 problem in life?
Someone out there needs to see this. It’s helpful, it’s needed, and most importantly – you get to help get the word out.
Thanks for your loyal support,
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