Saving for College – Is a 529 Plan Enough?
Saving for College
Does the thought of paying for your children’s college tuition scare you? According to bestcolleges.com, the average tuition and fees increased from $8,661 to $14,307 per year from 2000-2021. So, for a 4-year degree in 2024, you probably need to pay around $60,000 per child.
Even though I have allocated money every year for both my daughters’ college accounts, I am dreading paying those high price tags.
On the surface, saving for our kids’ college education can seem simple, just sock money away in a 529 plan and that’s it.
529 Plans
According to the IRS, a 529 plan is “a program established and maintained by a state, or an agency or instrumentality of a state, that allows a contributor either to prepay a beneficiary’s qualified higher education expenses at an eligible educational institution or to contribute to an account for paying those expenses.”
More Complicated Than Retirement Planning
I believe saving for college efficiently is more complicated than retirement planning. This is because if you overcontribute to a 529 plan, you will need to pay taxes and penalties if the funds aren’t used for eligible college expenses. Additionally, if you change the beneficiary to a non-family member, you will also incur taxes and penalties.
Based on the above, here are some important considerations:
- Unlike retirement, it is much harder to estimate how much your kids’ total college costs will be.
- Will your child get scholarships/grants/awards?
- What school will they go to? Is it a private or public university? Will the school be in-state or out-of-state? Will they go to school outside the US?
- Will they just take a traditional 4-year degree or will they eventually go to law school or medical school?
- Will they go to a community college and get a 2-year degree before going to a university?
- Will they actually finish the whole term or drop out in the middle?
- Will they skip college altogether in case they want to start their own business, become a YouTuber, or heaven forbid, get sick?
- The medium for undergraduate programs could be different in the future. For example, will there be more online programs than today? How much would those online programs cost compared to in-person tuition?
- How much money will they need for room and board?
- How many kids do you have?
- Will they have grandkids? Are there other family members that could potentially go to college if your kids don’t? 529 beneficiaries can be changed to siblings and other family members in the event that money remains unspent or a child’s circumstances change.
- How much will the 529 grow over your kids’ lifetime?
- Are the investment options good?
- How does your in-state 529 plan compare with others that are out-of-state? (Savingforcollege.com has a good resource for researching each state’s 529 plans here.)
Because these sets of questions have a wide range of potential answers, it is hard to calibrate the right amount of money you need to put into a 529 plan. If you under-contribute, you aren’t as tax efficient. If you over-contribute, you might need to pay penalties and taxes.
The Most Important Thing
I always tell clients that the most important thing in paying for your kids’ education is actually saving money. Since it’s almost impossible to be perfectly efficient, it might be best to slightly under contribute to your kids’ 529 plan, but also save additional money in a non-529 plan account to make up any potential shortfall. You could also slightly over contribute to your kids’ 529 plan and that would work fine as long as you’ll have a family member you can transfer the account to, such as a younger sibling, a niece or a nephew. Ultimately, it comes down to personal preference on how you would approach this. I prefer the former, because I don’t like paying penalties.
Aside from these considerations, you have to be informed that there are many kinds of 529 plans. Some have been rated highly by various investment institutions and some aren’t. Some charge high fees, and some don’t. There will be many times where your state’s 529 plans aren’t going to offer the best investment options. As such, you might be better off getting a 529 plan out-of-state, but in the process lose out on state tax deductions.
Additionally, if your 2023/2024 modified adjusted gross income is below $95,000-$110,000 ($190,000-$220,000 for a joint return), then you might qualify to open a Coverdell Education Savings Account (ESA). Please consult a tax professional to be certain. In my opinion, it is better than a 529 plan, because just like a regular brokerage account, you are not limited to a few investment options. In an ESA account, you can invest in any stock, bond or fund that your brokerage firm will allow. Unlike 529 plans, most ESAs don’t have underlying administration fees. You can compare 529 plans and Coverdell Education Savings Accounts here.
We Can Help You Pick the Right Plan
As part of our wealth management services, in addition to helping clients plan and save for retirement, we analyze their situation and offer them advice on how to save for their children’s college education without any additional charge. If you need assistance in this regard, please feel free to contact us.
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Earl Yaokasin, CFA, is an investment manager who runs WealthArch Investment Services in Pasadena, CA. He is a fiduciary with over twenty years of experience, and whose entire personal portfolio is managed by the firm in the same investments as the company’s clients. His firm focuses on value investing, similar to Warren Buffet’s successful approach, and disciplined strategies designed to create growth with downside protection, enabling clients to move steadily towards their life goals and aspirations with confidence.