In this show, Mike and Amy the characteristics of 529s and how they might fit into your education funding goals. Mike and Amy cover: 

• The two types of 529 Accounts (2:59)
• The pros and cons of each type of 529 (5:08)
• Types of qualified education expenses (6:30)
• 529s and scholarships/ penalty free withdrawals (13:08)
• State level tax benefits of 529s (15:04)
• State sponsored 529 Plans (15:32)
• Selecting a 529 beneficiary (18:38)
• Generational wealth transfer/ education funding (21:08)

Links:

www.savingforcollege.com

Operation Retirement Readiness:  www.operationretirementreadiness.com

Schedule a consultation with Mike: https://nextmissionfinancialplanning.com/contact/   

Schedule a consultation with Amy: https://www.instarfp.com/contact

Transcript:

00:00:00 Mike:

So, Amy, what are we talking about today?

00:00:02 Amy:

So today we’re going to talk about something new. We’re going to switch gears and talk about saving for college, which is another big expense item that people think about pretty regularly. And specifically, we’re gonna talk about one of the tools designed to help with saving for college. And that’s the 529. So the 529 is basically like a 401K only it’s used to pay only for education. So 401K’s are for saving for retirement and 529s are for saving for college.In my experience over the years working with people, they either have super strong feelings about these accounts, or they don’t pay any attention to them. What about you, Mike? What’s been your experience with 529?

00:01:17 Mike:

Yeah, there’s, there’s definitely, you know, concerns, I guess that some people have with 529s because again it’s, you know, pseudo locked into education. And so people are like, well, how, how do I know when my child is one or two when I should be starting this account? That they’re even going to go to college and so that’s a big thing that that people deal with and I think people get overly concerned with that. I mean, it’s not like you can’t get the money out. Yes, you’re gonna pay taxes on it. And yes, you may pay a penalty if you don’t use it for education, but it’s not as drastic and they can be very useful so that’s what I find that folks are concerned about with 529s.

00:02:17 Amy:

Yeah, same same. They also sometimes feel like they don’t perform very well. You know, I’m not sure why that is, but I have heard that or they just don’t understand the rules. They don’t want to deal with It. And you know the reality is depending on the situation, specifically your situation, they can actually be pretty flexible in a very valuable savings option depending like I said, depending on your. Situation. But before we jump too far into the details, Mike, can you just hit some highlights of the 520 nines for those who maybe never heard of them or have ignored them over the years?

00:02:59 Mike:

Definitely. Like you said, 529 accounts are similar, somewhat similar to a 401K allowing you to contribute money after tax dollars into that account. That will grow tax free as long as that money is later used for education. Qualifying educational expenses which. We’ll talk about. You can use that money. You know all the earnings that it’s had without paying taxes. So there’s really two main types. One is the prepaid college tuition. So basically with that you’re buying credits today at whatever prices are typically for a specific school and then you know when your child is 18, they graduate and they’re ready to go, you’ve amassed, you know, 2 1/2 years worth of college. And that’s already paid for. Or those are kind of less popular, mainly because it is typically by the school or by some group of schools. And so parents are like I don’t. I don’t know if my kids are really going to, you know, stay in state and you know with military folks you’re moving around all the time. That’s really hard to say that, yes, they’re gonna go back to Texas or Florida or Washington state and make that decision when there are three or four And you’re starting to accumulate. The Second one is very similar to the 401K. It’s an investment account where you’re just contributing to. You can pick the investments you want that invest in and then that just grows overtime and then when they’re ready, you’re just paying for school and whatever the current rates are really for whatever school they want to go to. So those are really the two accounts and or two types of 529 accounts that people use, but the investment account is definitely the much more popular option too.

00:05:08 Amy:

Yeah. Yeah, exactly. I mean, the prepaid plans might be really great for those people who, you know, you know, your kids are going to stay in state or that they’re going to go To some specific.

School for some reason, maybe everybody in your family goes to, you know this particular university but one. Military folks move around a lot and two kids have a way of doing exactly what their parents don’t want them to do. So they’re not very popular, but the flip side of the investment plan version you are taking on some market risk. Most people do choose to accept that market risk over long time horizons, so if you’re starting to save for college when you know, maybe even before your children are born. But if you’re starting, you know, 10-15 years, maybe even 18 years before they head off to school, people are willing to accept that market risk. Either way, a lot of the details around the accounts on how they work are pretty similar. For example, the types of expenses that are considered qualified expenses for are the same for both. Mike, do you want to walk us through what qualified education expenses for use of 529 money are?

00:06:30 Mike:

Yeah, definitely. I’ll hit on one thing before we jump to that the one thing that people may say, oh, they don’t perform very well is a lot of times you get into kind of an age based similar to a retirement plan where you’re picking the year you’re going to, you know, retire with these accounts. A lot of times you’re picking the year, the kids going to graduate in high school.

And so as you get closer, the funds automatically take on less risk because the last thing you want to have happen is, you know, you saved $80,000 for college and you’re a year out and the stock market craters and goes down 25%. Now you got $60,000. So they manage that and they put you on a glide slope to you know mainly having cash as you close in on high school graduation. So yeah, at that point you’re not generating A lot of return. So, folks say, oh, they don’t, they don’t return very well, but that’s really by design and not a bug as they say so. But yeah, as far as qualified expenses, of course tuition. Room and board. Even books and supplies can be used out of 529. Computers. If you need to pay for the Internet. All of those type of things, any kind of software, specialty things needed for the college classes as long as they’re kind of required for the course, they can be added and then a new thing that you can use 529s for is K through 12 Tuition. If kids are going to a private school, that’s a limit of up to $10,000 per year per beneficiary. So it’s a cap. But again, if you. You are going to send your kid to private school and you know that even before they’re born, it can make sense to start investing early. Or maybe grandparents have done that and that that can be a good way to also use 529.

00:08:43 Amy:

Yeah, yeah. And, you know, one note, these expenses, these qualified expenses, I just like to highlight. They underline that this list is specific to 529 qualified expenses. So there’s different qualified expenses for different things. So if  your family is eligible for education tax credits, those expenses are a little bit different. So it’s important to make sure that you know  Qualified expenses for 529 plans because there are different lists. And then, you know another qualified expense that is also new is that you can use up to $10,000 to pay off school loans. That is a lifetime cap. So whereas the K through 12 tuition $10,000, that’s per year per beneficiary. The $10,000 school loan is a lifetime cap per beneficiary. So you know, somebody finishes school. You think there’s money left, but you know you didn’t have quite enough in the five or quite enough ways to use 529 money or you continued to save or another child didn’t go to school and somehow you have student loans. You can use up to $10,000 to pay for school loans. And then the very newest way, in fact, just the beginning of this year is the first time you could do it, is the ability to transfer up to $35,000 from a 529 to a Roth IRA. It’s a lifetime limit per beneficiary, and there’s a ton of rules around when and how this can be done, but with proper planning, this new rule could make a huge difference in retirement planning for your children. Whether you’re doing it deliberately or just because you have leftover money. I mean, just imagine the power of $35,000 Compounding 5-6-7-8 percent per year for 40 or 50 years. I mean, depending on actual returns, Mike, we’re talking about anywhere from, you know, a few 100,000 to over $1,000,000 just because you could roll 35,000 from a 529 to a Roth IRA.

00:11:04 Mike:

Yeah, that’s really powerful. Like you said, brand new, so make sure you’re checking all the rules, talking to your tax preparer. If you’re thinking about doing this and or financial planner on how you go about doing this, it is nice that they finally came up with that. Some of the other rules around it. The account meaning the 529 account has to be open for at least 15 years. And the money that you’re taking out has had to have been in for at least five. So it’s not something that. You know if you haven’t started the 529 yet, it’s not something that’s going to happen overnight, but again you’re going to have tax free growth there. So if you do have money leftover, even if you don’t meet that timeline and you know you don’t need it for your own retirement or you know you really want to. Help out, help out your you know kids typically who are the beneficiary or the beneficiary of the 529? You can look into this and maybe you got a hold of it a few more years, but then you’ll be able to do that one other thing. It is subject to whatever the maximum 5, Roth IRA or IRA limits are at that time. And the other piece is that the beneficiary also has to have enough earned income, so.  If they’ve only got $5000 of earned income, that’s the limit for that year, that you’ll be able to transfer. So again, lots of rules that you need to be aware of, but something that will hopefully. You know, make people go well. I do have an out that I’m not going to pay a penalty and taxes on if I, you know, end up. Not if my child ends up not going to college or they get a lot of scholarships or good old Military Academy that I can now still use that money without issue.

00:13:08 Amy:

Yeah, I mean it’s a great add, lots of complexity there, making sure that you do it the right way for the right reasons, but it’s a great option. Another way that you can get money out of the 529. So a lot of times I’ll hear people say what if my kids get a scholarship? Or for military families, you know, I want my kid to go to one of the academies. You can actually take money out of a 529 penalty free. If your child receives a scholarship. So if your child receives an ROTC scholarship that’s worth, say, $40,000, whatever, whatever it’s worth, you can take that amount out of the 529 without paying the 10% penalty. Now you will pay tax on the capital gains. So there’s an amount of that 40,000 that’s coming out that you personally put in. But then there’s some portion that’s gain, you’ll pay tax on the gain part at capital at capital gains rates. And this is essentially what would happen if you had invested in a brokerage account and so it’s just it’s just about the same. The only difference is you don’t have to pay tax on the dividends and the growth or any sales that you may have made over the years in the brokerage account, you don’t have to do that in the 529. So no penalty, it grows tax free, you will need To pay capital gains on the gain portion that you take out, but it’s another way to get money back out of a 529 without the penalty and it’s almost like you had it on a brokerage account. Except for you didn’t have to worry about the tax piece of things over the years. There’s some other things that like tax advantages to these accounts, particularly around state tax advantages. Mike, what do you want to tell us about state taxes?

00:15:04 Mike:

Yeah, well,  we said, you know, the money goes in after tax dollars. That’s at the federal level at the state level. Some states do offer tax breaks credits for Funding 529 and so that can be a good option if your state allows, you can save more on your state taxes even by funding your 529.

00:15:32 Amy:

Yeah, and. And you know that you make the great point, the 529s are usually sponsored by a state. Not all states offer 529. If a state offers a 529, some of them only offer them through a financial advisor, meaning you have to work with somebody in order to open it. An individual can’t open it. Some states only offer one that can Only be offered by and or opened by individuals, and then some states offer both versions. Every plan is a little bit different. They have different fees, they have different investment options, they have different contribution limits and rules, but they are a great resource for comparing these 529s. You can go to savingforcollege.com, which does a good job breaking down the basics of each state plan, even kind of letting you know whether or not that particular state offers any sort of tax break, whether it’s specific to the state plan or if it’s any plan. And then in terms of performance, Morningstar actually publishes annual rankings for 529 plans in terms of investment performance and quality of the investment management team. So those are two great resources to help you select a plan that makes sense for your overall situation while making sure that you understand what the costs are and and what. Investment options you might have access to.

00:16:51 Mike:

Yeah, that’s all great points. If you don’t get a Tax. Break definitely shop around. Look at the Morning Star rankings because again some of the fees and things like that are better with certain 529 plans than others. So that’s definitely important. So let’s talk a little bit about who can. Actually open a 529 plan and really it’s any adult. You can start it. You don’t have to have kids to do it. I mean you can Open it for yourself if you want to. If you’re planning to go back to grad school at some point or you know, maybe you’re getting your degree later in life, you can. You can fund a 529 and you would be the owner. You would be the one contributing the money. You would quote, own the account, and then the second piece is then you would have a beneficiary. And that’s who that money is going to go to when. They have a need for college costs.

00:17:52 Amy:

Yeah. And, you know, one thing to point out is that and that you alluded to is you Can use in 529 plan of any age which is a little bit different than the older Coverdell Education savings accounts. I still see those from time to time. The Coverdell accounts Have an age limit of Age 30. So that’s something to keep in mind if you have one of those old education savings accounts, is just making sure that you know that those funds have to be used by the beneficiary by each 30 beneficiaries can be changed for a 529. Again, it can be anybody of any age. In terms of, you know, relative. But Mike, why don’t you tell us more about changing beneficiaries and who can be a beneficiary and all that kind of stuff?

00:18:38 Mike:

Basically the beneficiary you know, needs to be a first cousin or closer. So if you’re the owner or your spouse. Your parents, aunt and uncle. Brother. Sister. Your kids, of course. And any of your kids, descendants or the spouse of any of your kids descendants. So kind of that line is is can be beneficiaries from within your own and the account owner is the one who gets to direct the funds. So if. You know you’ve got identified, you have three kids and you’ve got three accounts. If child #1 doesn’t want to go to school. You can redirect that to child #2 and child #3 and and there’s no no issue there. You know, sometimes people don’t like accounts. They say, you know, it’s too rigid. You want to talk a little more on that, Amy.

00:19:38 Amy:

Yeah, yeah. I mean, the number one thing I hear about why people don’t have a529.  Just in the last few minutes, what we’ve talked about is The flexibility to change beneficiaries so if your children decide not to go to school, but your spouse wants to go back to school, you can change the beneficiary. If you would like to help family members out and your children aren’t going to use the 529 and you have a mind to help your family members, you can change the beneficiary. If you want to go back to school. You can change to the beneficiary. In terms of funding qualified expenses, it isn’t just college expenses at this point. We talked about the $10,000 lifetime limit for paying down school loans, again for any beneficiary that might just review. So if you have a mind to help family members out, that might be a way that you can help family members out and also the K through 12 Expenses. So it, you know, military families move around a lot, sometimes landing in areas where they don’t. They don’t love the schools, so they might choose to put their kids in private school. So those K through twelve $10,000 per year beneficiary. That’s more flexibility. The ability to withdraw funds if the child receives a scholarship without having to pay the penalty is more flexible and there’s no age limitation, which means that you can keep these accounts around for a while, which you know we’re not going to get into, but I’ll let Mike talk about the concept of how important the no age limitation flexibility factor is.

00:21:08 Mike:

A lot of folks on the, you know More ultra wealthy side see this as a great way to just provide dynastic generational wealth. As we talked about you can give it to a lot of family members down the line and so saving in this vehicle grows significantly over time. Just can fund again multi generational education. Courses for kids, grandkids, great grandkids. So if you have the money and and you know, I mean, I think the one thing we didn’t hit is How much can you contribute to these accounts? And so it’s typically tied to the maximum gift exclusion per year, which I believe for 2024 is 17,000 or at least in that ballpark. Make sure you check that it says of 2024, but that’s a lot of money that you contribute each and every year. And if you have that and have a generation you know. Way to pass education on to kids, grandkids, and and even further down and have that money. It could be a great way to save, tax free and just fund that for you to know all your descendants. So it’s a big thing.

00:22:42 Amy:

Yeah. Yeah. And I think I think you were going to start to talk about too, you know, how do you balance? Funding, education and funding retirement. So what are your thoughts around that?

00:22:55 Mike:

Yeah, if you’re if you’re not somebody who is maxing out their 401K and their IRA’s and and you know that’s not your problem, this is definitely something to to think about is, you know, which do you, which do you fund, do you fund the kids education or do you fund your retirement and, you know, one of the sayings is. Can’t take loans for retirement? I kind of like to think of it. The Roth IRA is really powerful. If you qualify for that and you know if that’s something you don’t have enough to do both the Roth IRA, I kind of lean toward. Going toward the Roth IRA. It’s also relatively flexible. One of the very nice things is you can pull out any contributions that you’ve made To a Roth IRA. At any time, for any reason, and there’s no penalty, no tax, anything like that. So right now the annual limit is about $7000. So if you and your spouse are able to contribute and fully fund, your IRA starts when your Kid is very young.  You know that’s $14,000 a year. We’ll round up, say, 20 years. You know, you’ll have $280,000 of contributions. That again, if you don’t have the ability to do both, takes away the issues of what if they don’t go to school? What if they get scholarships and, you know, some of the objections. That’s kind of my thought. It is fun that first it gives you options and maybe early. You’re doing the IRA and then as your income increases, you are able to start funding the 529 if they’re closer to actually going into school and have a better idea of what they want to do. But in general that’s my preference. How about you, Amy?

00:24:56 Amy:

Yeah, I mean it, that’s a really great thought. And in general, I agree with you being able to and and that’s actually one of the reasons that I you know if if the client is able to contribute to a Roth, meaning they’re they’re under the the phase out limit for Roth IRA contributions and they have earned income for the year, I really want somebody to open a Roth IRA and put some money in it. Because you know Mike’s exactly right, you can withdraw your contributions.

 Without penalty and but the key to that is there’s one caveat. The caveat is the account had to have been open for five years. A lot of the rules around the Roth IRA have the requirement that you have to have the account open for five years. So I agree that the Roth IRA can be if you have to make a choice between the two, you can’t do both. And you’re able to contribute to a Roth IRA. Then it’s a great option. Just keep in mind that you can’t start. You know you can’t start the Roth IRA when your child’s 15 years old and think that you will be able to just pull that money out without a penalty when they turn, you know, 18 years old and they start school.

00:26:09 Mike:

Good point, good point. Anything else we missed on the 529 Amy that you think we need to hit?

00:26:14 Amy:

I I don’t think so. I just hope that this podcast gives people an opportunity to sort of rethink, maybe if they’re in the camp of hating these accounts because they feel that they aren’t flexible. I hope they’ll give them a second look and just consider how or if it might fit into their overall education plan.

00:26:39 Mike:

Yeah, I think it’s, it’s great. Definitely another powerful tool in the toolkit that folks should consider when they either think or know they’re going to have Expenses for college or school, and now you know, even private. School’s a good way to do it and also you know a good option if you’re a grandparent. Good way to save for your, you know, grandkids and help them out down the road. And you know versus maybe buying them that? Next to put some money away and they’ll be happier not having to take out college loans. You know, 15 years in the future, so definitely, definitely a powerful tool that people you know need to be aware of and fully consider when they’re figuring out how to save for college.

00:27:35 Amy:

Exactly. Well, Mike, this has been great. It’s always good to talk with you and I’m looking forward to our next podcast.

00:27:43 Mike:

Yeah, it’s been great talking to you. Thanks again. And we’ll see you in a couple of weeks.