Should you contribute to a 529 plan?

With the kids back to school, you may be one of the many parents who have future college expenses in mind. Should you save for college? If so, how?

You might be surprised by this first question. Many parents take it for granted that they should save for college, but there are actually reasons not to. First, there is the “oxygen mask rule”. When you are on an airplane, one of the emergency procedures is to make sure your oxygen mask is in place before helping your children with theirs. It might sound heartless, but you won’t be able to help her or anyone else if you don’t make sure you can breathe first.

The same rule applies to helping your children with their college expenses. As important as education is, they can still borrow money (often with low-interest, tax-deductible federal student loans) or even work for it. In fact, there are studies showing that students who work in school do better than those who don’t, because knowing how hard they work for it can motivate them to take their education more seriously.

Even the most basic job can also teach real-life skills that can help them find jobs later on. In my case, I have helped pay much of my college expenses by selling knives to people, helping run a branch for this same company, organizing student tours, giving SAT classes, and by selling advertising for the school newspaper. Each of these positions has given me valuable sales and public speaking skills. In fact, my success in selling knives was a key factor in my hiring for a previous position with a large national investment brokerage firm. I was never even asked about my GPA or my degree in economics.

On the other hand, you can’t borrow to pay for your retirement (at least without taking out a reverse mortgage on your home, which can get very expensive). Paying off credit card debt, building an emergency fund, and securing adequate insurance coverage should also be priorities. After all, example is one of the best ways to teach your kids about money. You can always decide to help them pay off their loans if it turns out that you have more money than you need.

If you decide to save for their education, another misconception is that you need to save enough to fully pay for all of their expenses. The reality is that very few families actually pay the price of the sticker and trying to save that amount would be too intimidating for most people anyway. Even if you have a relatively high income, you might be surprised to find that your child may still be eligible for financial aid, especially if you have more than one child attending college. You can estimate how much you might have to pay out of pocket on sites like this. You can then break that amount down into a monthly savings goal.

Once you know how much to save, a 529 plan can be a great vehicle. This is because the income from these accounts is tax-free if used for qualifying education expenses, which also include vocational and graduate studies. If you’re worried about inheritance taxes, you can also contribute up to 5 years of gift tax exemptions upfront.

The biggest downside is that you will have to pay tax plus a 10% winnings penalty if you use the money for anything else. There are still some exceptions. For example, you can withdraw the amount of scholarships your child earns without penalty or use the money for the education expenses of a parent of the child if he decides not to go to school at all.

If you want to open a 529 account, you will first need to decide which state plan to choose, as each state has its own plan (s) with different investment options and you are not limited to your own state. This means you can live in California, open a 529 account in Texas, and your child can attend school in New York City. However, you may want to check to see if your state offers a tax deduction or a matching contribution to contribute to its scheme. You can check out this list of some of the best plans based on investment options and benefits for residents.

Once you’ve chosen a plan, your final decision is how you want to invest the money. A common option is an age-based portfolio, in which the allocation of investments automatically becomes more conservative as the child approaches 18. This can be a good idea because you don’t want to be invested aggressively if the market drops by the time the tuition comes due. Here are some other tax-efficient ways to save for education and how they stack up:

UGMA / UTMA accounts: These are deposit or investment accounts opened in your child’s name.

Pros: You have more freedom in how the money is invested and there is no penalty for using it for non-education expenses. The first $ 1,100 of annual income is not taxed and the next $ 1,100 is taxed at the child’s tax rate (which is probably zero).

Disadvantage: The money is considered your child’s money. This means that he cannot be transferred to someone else and can use it for any purpose (including a new sports car) once he reaches age. majority in your state. It also counts more against your child in determining financial aid eligibility than a 529 plan (which is considered a parental asset rather than a student.)

US Savings Bonds: These are bonds guaranteed by the federal government and issued by TreasuryDirect.

Pros: Series I bonds currently pay 3.54% with minimal default or market risk and taxes can be deferred. If the bond is in your name and you meet certain income limits, the interest can be used tax-free towards your child’s eligible education expenses, but there is no penalty if you want to. ‘use for something else.

Disadvantage: You can only buy up to $ 10,000 of bonds per year per person, you cannot buy them back in the first 12 months, and you lose 3 months of interest if you buy them back in the 5 first years. They also don’t have as much return potential as more aggressive investments.

Coverdell Education Savings Account: It’s like a Roth IRA for education.

Pros: Income is also tax-free if used for qualifying education expenses, but you have more investment flexibility than a 529 plan and the money can also be used for student expenses. private primary and secondary schools.

Disadvantage: There is a contribution limit of $ 2,000 per child per year, a tax and penalty for ineligible withdrawals, and the money must be withdrawn by the time the child turns 30.

As you can see, there are a lot of choices when it comes to saving for college. The best for you depends on your individual situation. Just make sure you have your oxygen mask on first.

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