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Over the last 17 years, I have been saving a modest amount each month in a 529 plan. I have been doing the same for my daughter for the past 14 years. Given the market performance and our steady contributions over time, these modest monthly contributions have grown to be a sizable amount. While I am thrilled that we should have most of our college cost covered, I’ve often wondered if the 529 plan was the best bet in saving for college.
I have done much thinking on this topic, and I’m sure many others have as well. I am creating this forum to share some analysis/thinking on this subject and to hear what others have to say.
I have one final semester of payments for tuition using the 529 plan that we funded for both kids, and it will use up all that we put aside. I think it was a fantastic thing to have, not just for the tax free growth, but more to simply have it there to pay for college and thus not pull it from our other taxable savings. Like was mentioned earlier I found that to be a comforting feature. It has been extremely easy to pull the money out to pay the bills, and our fund was a very low fee fund through California’s Scholarshare (TIAA-CREF). Although we moved to Minnesota we still get a tax credit for contributing to the 529, which has been nice also. It was great for us.
As an aunt and uncle to several nieces and nephews soon college-bound, we have used front-loaded 529s to help lower our estate value below the federal (and state if it applies) estate tax boundary. Our plan is to make more front-loaded gifts to their 529s every 5 years so the funds can be used for their children, or for future graduate education.
We had not thought about the “save it for later” approach just paying the college directly which is a good way to channel more money to the kids without the extra IRS reporting for front-loaded gifts. A useful idea provided we live long enough to see them through all their education years.
As mentioned in an earlier post, I was relieved to find that it should be easy to access the funds that are in the 529 plan. I tell Schwab what I’ve spent and they will send the money from the 529 plan to cover the cost. The 529 plan can also cover the college costs directly (i.e. send the funds to the college), but that sounded like a trickier route to take. By the end of four years, the balance should be down to zero. I am good with that.
I am well aware there are other schools of thought on how to approach 529 balances. Many have an eye towards preserving the balances for the future. In one case, I have a friend who is funding college without tapping his child’s substantial 529 account. His thinking: the 529 plan is an efficient vehicle to pass money to his child who can use the funds to fund college costs for his grandchildren. While generous and forward-thinking, this approach does not work for me.
First off, as mentioned in prior posts, 529 plans carry fees that can offset the tax deferral benefit. If you have your 529 plan with a low cost provider, then the tax benefit math may work. If you have your plan with a company – like Schwab – who levies about 1% per year, you may find that the tax benefit is offset by the fees.
My second argument against this “save it for later” approach is that you don’t know what tax changes and financial aid rules will be in the future. While unlikely, it could be that withdrawals from 529 plans are taxed in the future. It could also be that there is a change in the student aid formula that makes 529 plan accounts unfavorable to hold.
A final argument against such a “hold on to it” approach is that there is no certainty you will have grandkids. And if you do, it could be they will not need money for college as they choose to enter a trade or they end up earning a scholarship. In a case where the funds are never used, you will certainly pay a hefty tax to access the funds.
Another benefit I see with the 529 plans is that it’s easy to pull money from the account to reimburse yourself for college-related costs you incur. About a year ago, I talked to a 529 specialist at Schwab. Given that my balance had grown quite a bit, I started to worry about how to access the funds. In past lives, I’d found it challenging to access dependent care flex spending and HSA accounts. So as college for my oldest was drawing near, I figured I’d check in to understand the process to access funds.
To my surprise, it will be relatively easy to access the funds. I will simply communicate to Schwab the qualified costs I’ve incurred and they will cover it accordingly. The qualified costs include tuition, room, board, books and technology costs. For the latter two costs, it’s my understanding that they are covered so long as the costs are paid directly to the school.
The key costs not covered would be travel to the school, any health fees levied by the school, and fees for extracurricular activities.
With the cost of college these days, I am fairly confident it will be no problem for us to drain our 529 balances.