The best gift any parent can give a child besides unconditional love is a great education. A 529 college savings plan is a solution that is designed to help families tax-efficiently save for future college costs.
You contribute after tax money with the benefit of paying zero federal and state income taxes on the profits when it’s time to use the funds to pay for college.
If your child does not end up going to college, all’s not lost. You can either name a new beneficiary (different kid) or just pay the taxes on profits.
My goal is to max out my son’s 529 college savings plan before he turns 18. I want him to focus on his studies and graduate with zero student debt.
The various complaints I read today about young adults with student debt are disheartening. The struggles range from saving for a house, saving for retirement, accepting a low-paying job, to starting a family.
Below are the most important pieces of information you need to know about making the best 529 plan decision. Feel free to provide feedback at the end on anything that I may have missed. I’ve tried to cover all the questions I had before opening up an account.
529 Plan Contribution Limit
There are two questions to answer here. The first is what is the total maximum you can contribute to your 529 plan. The second question is how much can you contribute each year to your 529 plan.
Total Maximum Contribution To A 529 Plan
To qualify as a 529 plan under federal rules, a state program must not accept contributions in excess of the anticipated cost of a beneficiary’s qualified education expenses.
For example, 1 year at a mid-priced college for an in-state student can run around $24,000. A year of private school can cost around $45,000. Further, it is assumed that the average student would take no longer than five years to graduate.
Therefore, the average 529 plan limit is roughly $300,000, depending on the state. When the value of the account (including contributions and investment earnings) reaches the state’s limit, no more contributions will be accepted.
For example, assume the state’s limit is $300,000. If you contribute $250,000 and the account has $50,000 of earnings, you won’t be able to contribute anymore. The total value of the account has reached the $300,000 limit.
These limits are per beneficiary. Thus, if both you and your father each set up an account for your child in the same state, your combined contributions and earnings can’t exceed the plan limit.
Otherwise, a kid could possibly end up with multiple 529 plans worth millions. Just imagine parents, both sets of grandparents and long lost aunties and uncles making contributions to the same child.
529 Plan Annual Contribution Limit
You should only contribute a maximum of $17,000 a year for 2023. Anything more involves filing a 709 federal tax form taking a deduction against your lifetime gift-tax exclusion limit.
However, 529 plans allow you to superfund. In other words, you can gift an individual a lump sum of up to $85,000 in a single year (5 years X $17,000). That’s up to $170,000 for joint gifts. Superfunding does not count against your lifetime exclusion. This is provided you make an election to spread the gift evenly over five years.
In other words, once you gift $85,000, you strategically shouldn’t gift more money until the sixth year. This is a valuable strategy if you wish to supercharge the 529 immediately.
Who Can Contribute To A 529 Plan?
Anyone can contribute to a 529 college savings plan account and can name anyone as a beneficiary. Parents, grandparents, aunts, uncles, stepparents, spouses and friends are all allowed to contribute on behalf of a beneficiary.
There are no income restrictions for the contributor. The maximum contribution limit applies to the beneficiary, not the individual making the contribution. Balances designated for a specific beneficiary cannot exceed the maximum allowed by the state’s 529 plan.
Can You Open A 529 Plan Before Your Child Is Born?
Yes you can. But to do so, you need to initially open a plan under your own name. Then, transfer the plan to your child after birth due to the need for a social security number.
But before you open a 529 plan for your unborn child, max out your 401k and IRA first. Make sure you also plan to have kids or are able to have kids. Sometimes nature has a way of changing outcomes.
Personally, I’d wait to open a 529 college savings plan until your child is born. Just make sure to set yourself a reminder. Sleep deprivation from a newborn is a given and could cause you to forget.
While you’re at it, you might as well open up a custodial Roth IRA and custodial investment account for your children too. To contribute to a custodial Roth IRA, however, required a child to have earned income.
Does A 529 Plan Affect My Financial Aid Package?
When you apply for the Free Application for Federal Student Aid (FAFSA), it’ll try to ascertain your income and total assets. Logically, the higher your income and higher your assets, the less aid you will receive.
Assets in a 529 plan owned by the student or her parents count against need-based aid. Those in a plan owned by anyone else (including grandparents) don’t.
But once grandparents or other relatives start taking money out of a plan to help pay those bills, the reverse is true. The withdrawals can hurt you even more than if the plan was owned by the student or parent for next year’s financial aid package.
The 529 plans owned by college students or their parents count as assets. Thus, they reduce need-based aid by a maximum of 5.64 percent of the asset’s value. That means if you have $50,000 in a college-savings plan for your daughter, her aid would be reduced by roughly $2,820.
Have Grandparents Be Owners Of The 529 Plan And Grandkids As Beneficiaries
However, if the 529 plans are held by grandma and grandpa, they won’t appear on the FAFSA as assets. Instead, as the money is withdrawn to pay for tuition or other educational expenses, that amount must be reported on the next year’s financial aid forms as untaxed income to the student. It can reduce the amount of aid by 50 percent.
Let’s say that same $50,000 529 college-savings plan was owned by the grandparents. If the student withdrew $10,000 from it one year, that withdrawal could increase the amount the family is expected to pay for college (and reduce the aid) for next year by about $5,000.
The Name On A 529 College Savings Plan Matters
Therefore, the logical conclusion is to either have the 529 plan under your child’s name or your name. This will minimize the reduction. Or, draw down the 529 plan under the grandparent’s name in the very last year of college.
It’s worth investigating how to reposition assets and income two years before your child applies for financial aid. Although it may not be worth it due to tax and performance consequences.
Can You Change The Beneficiary Of The 529 Plan?
If the existing beneficiary no longer needs the funds in your 529 account (e.g., he or she gets a full scholarship, decides not to go to college, or passes away), you may want to designate a new beneficiary instead of pay the taxes and penalty. Just fill out a change of beneficiary form and submit it to your 529 plan administrator.
If the existing beneficiary needs only some of the funds in your 529 account, you can also do a partial change of beneficiary. This involves establishing another 529 account for a new beneficiary and rolling over some funds from the old account into the new account.
The new beneficiary must be a family member of the old beneficiary in order to avoid paying taxes and penalties. According to Section 529 of the Internal Revenue Code, “family members” include children and their descendants, stepchildren, siblings, parents, stepparents, nieces, nephews, aunts, uncles, in-laws, and first cousins. States are free to impose additional restrictions, such as age and residency requirements.
Note, if you have a lot of funds, you can even use the 529 plan as a generational wealth transfer vehicle! A 529 plan is probably one of the best ways to gift money without gifting money.
What If You Have Money Left Over After Your Child Finishes College?
You can save the money for graduate school or transfer the remaining funds to another child. In addition, you could keep the money growing tax free for potential grandchildren. Or pay the 10% penalty and taxes on the profits.
The exceptions relate to withdrawals made on account of the beneficiary’s death, disability, receipt of a scholarship, or attendance at a Unites States military academy.
A very small handful of 529 savings plans, and nearly all of the 529 prepaid tuition plans, impose a time limit on your 529 account. If you bump up against one of these limits, you can look to move your funds to another 529 college savings plan via a qualifying rollover.
New 529 Plan Rollover Rules Due To Passage Of Secure 2.0 Act
Money withdrawn from a 529 plan must use for qualified educational expenses. If not, you’ll pay ordinary state and federal income taxes (at the beneficiary’s tax rate) on the money, as well as a 10% penalty.
Now, the penalty can be waived if your kid wins a scholarship, gets into one of the U.S. military academies, receives support from an employer or for several other reasons – but that’s just the 10% penalty. You’ll still need to pay the tax bill.
You used to be able to get around that penalty by transferring the account to another beneficiary – even yourself or a spouse – in your family or extended family, including in-laws. But without an eligible recipient to use the money you were stuck paying both the tax and penalty – until now.
Rolling Over A 529 Balance Into A Roth IRA
The rollover allowance starts in 2024 and comes with several limits. First is that the amount rolled over can’t be more than the Roth contribution limit, which is $6,500 this year. You also can’t roll over more than $35,000 total in the beneficiary’s lifetime. You also can’t roll over contributions or earnings from the past five years.
Another condition is that the 529 plan must have been open for at least 15 years. Experts are unsure whether changing the account beneficiary requires a new 15-year waiting period. Also unknown until the IRS issues rules is whether withdrawals of earnings from 529 plans transferred to a Roth account will be subject to the rule that requires earnings to remain in the Roth account for at least five years.
However, the rollover contributions aren’t subject to the Roth IRA income limits of $153,000 for single filers and $228,000 for joint filers this year. Families who’ve contributed to 529 pre-paid tuition plans – where they purchase tuition credits at the current rates – haven’t had to deal with the issue, since those plans refund only the contributions, which are made with after-tax money.
Why The 529 Plan Rollover Is Now Allowed
“Families and students have concerns about leftover funds being trapped in 529 accounts unless they take a non-qualified withdrawal and assume a penalty,” a summary statement from the Senate Finance Committee said.
“This has led to hesitating, delaying, or declining to fund 529s to levels needed to pay for the rising costs of education. Families who sacrifice and save in 529 accounts should not be punished with tax and penalty years later if the beneficiary has found an alternative way to pay for their education.”
Do You Need to Get A 529 Plan From Your State?
No. Every plan allows the profits to be withdrawn federal and state tax free if the funds are used to pay for higher education (e.g. college). If the funds are not used for college, then normal taxes on earnings apply. There is no tax due on contributions as the 529 was funded with post-tax dollars.
The reason you may want to choose your state’s 529 plan is due to state tax deductions on your contributions. But some states, like California, offer no state income tax deduction. Therefore, it makes sense to search around the country for the best plan possible.
You can use your 529 from whichever state to pay for college in any state.
What Is The Penalty For Withdrawing Early From A 529?
If you withdraw the funds early to pay for something other than higher education for your beneficiary, then you must pay a 10% tax plus normal federal and state income tax on the profits.
However, if there are no profits, there are no penalties and taxes to be paid. For example, if you funded $20,000 and due to a bear market you now only have $15,000, all withdrawals are penalty and tax free.
Can You Dictate A Certain Percentage Of The Contribution To Be In Cash?
Let’s say you plan to jump start your child’s 529 plan with $75,000, but you’re worried about a stock market correction. You can’t tell the administrator to only invest $30,000 and keep the $45,000 in cash until you see better opportunities.
The solution is to just fund what you are willing to invest. For example, you can send five different deposits totaling $75,000 in a two year period up to five years.
Can you Spend The 529 Plan On Grade School Tuition?
Under the latest tax plan, up to $10,000 of a 529 college savings plan can be used per student for public, private and religious elementary and secondary schools, as well as home school students. In other words, a 529 plan isn’t just for college tuition anymore. This is HUGE!
If you plan to send your children to private grade school and pay the big bucks, then a 529 plan becomes even more valuable.
Who Manages The 529 Investments?
Once you understand if there are any tax deduction benefits for choosing your state (e.g. state tax deduction), then you should go about identifying which state has partnered up with the best money management firm.
Given I live in California, there are no state tax deductions. Thus, I decided to focus on which states use Fidelity, Vanguard, and TIAA-CREF because I believe they are the best firms.
I’ve used Fidelity for the past 16 years due to them administering my company 401k and now my Solo 401k and SEP-IRA. As a result, I’m comfortable with their service, products, interface.
Vanguard is obviously a top choice due to its low expense ratio. Finally, TIAA-CREF is another money manager I’ve worked with in the past. My colleague of 13 years is a Managing Director there. And, they started off as a Teachers Insurance and Annuity Association—College Retirement Equities Fund (TIAA-CREF).
Here’s Fidelity’s various 529 plan strategies with expense ratios.
Fidelity’s Age-Based Strategy includes portfolios that are managed according to the beneficiary’s birth year. The asset allocation automatically becomes more conservative as the beneficiary nears college age.
Your beneficiary’s birth year will help determine the Age-Based portfolio in which you’ll invest.
This strategy offers a choice of three types of funds:
Fidelity Funds – 1.04% average expense ratio
- Seek to beat a combination of major market indices over the long term
- Portfolios invest solely in Fidelity funds.
- Managed by dedicated Fidelity portfolio managers
Multi-Firm Funds – 1.2% average expense ratio
- Seek to beat a combination of major market indices over the long term
- Portfolios invest across multiple fund companies, offering an opportunity to diversify your funds.
- Managed by dedicated Fidelity portfolio managers
Fidelity Index Funds – 0.13% expense ratio
- Seek to closely mirror the performance of a combination of major market indices over the long term
- Portfolios invest solely in Fidelity Index funds.
- Passively managed; securities currently held in the respective index determine investments.
I hate spending money on excessive management fees because most fund managers underperform their respective indices. As an example, for 2016, the performance for each category was 16.32% Index Funds, 18.33% Multi-Firm Funds, 19.34% Fidelity Funds. This means it may make sense to pay 0.91% more in fees for the Fidelity Funds due to the 3.02% outperformance.
However, over a 10-year period, it’s unlikely the Fidelity Funds will outperform. Whereas you are guaranteed to pay 10% more in fees during that time period. Hence, I’m always going to select the Index fund route for a 529 plan.
Related: How To Analyze And Reduce Excessive Fees In Your 401k
The Best 529 College Savings Plans
Given you’re free to choose any 529 college savings plan you want, focus on the best. Let’s look at a list of the best 529 plans determined by Morningstar, one of the most trusted financial rankers.
As you can see from the chart, you might as well choose a 529 plan from Nevada, Utah, Virginia, Maryland, or Arkansas. They are rated gold or were once rated gold.
In my opinion, the Nevada Vanguard plan looks like the #1 choice, followed by the California TIAA-CREF plan since I’m not familiar with T. Rowe Price or the other plans. I’m disappointed the Delaware Fidelity plan is only rated a neutral since it would be so easy for me to just go with them.
As written by Morningstar, “These plans follow industry best practices, offering some combination of the following attractive features: a strong set of underlying investments, a solid manager selection process, a well-researched asset-allocation approach, an appropriate set of investment options to meet investor needs, low fees, and strong oversight from the state and program manager. These features improve the odds that the plan will continue to represent a strong option for investors.“
Profiling TIAA-CRF’s 529 Plan
Here’s a quick snapshot between the California TIAA-CREF 529 plan and the Nevada Vanguard 529 plan. Sorry the font size is so small. Just zoom in. Based on the comparison chart, there doesn’t seem to make that big of a difference, especially if you are just buying index funds with similar expense ratios.
Here is another popular ranking by SavingforCollege.com. I’m looking at the 5-year and 10-year track record rankings instead of just the 1-year to iron out any anomalies.
Find A Plan You Like And Enroll
Once you’ve determined what you like, you can enroll directly with the plan. Simply Google the plan name or apply through your existing brokerage like Fidelity who has plans in Arizona, Deleware, Massachusetts, and New Hampshire.
They’ll give you more information like I have provided in this post to make an informed decision.
Wealth Planning Recommendation
College tuition is now prohibitively expensive if your child doesn’t get any grants or scholarships. Therefore, it’s important to save and plan for your child’s future.
Check out Personal Capital’s new Planning feature, a free financial tool that allows you to run various financial scenarios to make sure your retirement and child’s college savings is on track.
They use your real income and expenses to help ensure the scenarios are as realistic as possible.
Once you’re done inputting your planned saving and timeline, Personal Capital with run thousands of algorithms to suggest what’s the best financial path for you. You can then compare two financial scenarios (old one vs. new one) to get a clearer picture. Just link up your accounts.
There’s no rewind button in life. Therefore, it’s best to plan for your financial future as meticulously as possible and end up with a little too much, than too little! I’ve been using their free tools since 2012 to analyze my investments and I’ve seen my net worth skyrocket since.
Pay For Your Children’s Education Through Real Estate
In addition to investing in stocks and bonds in a 529 plan, I recommend diversifying into real estate as well. Real estate is a core asset class that has proven to build long-term wealth for Americans.
Real estate is a tangible asset that provides utility and a steady stream of income. If you buy one physical property when the child is born, it could fund your child’s education after 18 years. You can either take out the equity in the property or pay for college with the rental income.
If you want to invest in real estate hassle-free, then take a look at private real estate investing.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. The firm manages over $3.5 billion and has over 350,000 clients. It specializes in Sunbelt single-family homes.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.
I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000.
Hopefully my kids get scholarships and I use their 529 to send myself to Europe on an exchange student program when I am 55 years old!!!
A ton of info and very helpful, thanks! I didn’t know I could establish it in my name until my child is born because I asked about that. We established it a few months after his arrival until we got the SSN. But I do agree on maxing out other accounts first if at all possible.
Hi Sam,
I went a little different route with my daughter. When she was born I put 5k into Amazon stock at 33.00 a share intending to hold it till she went to college. I was convinced this was going to be the greatest company ever. I than sold it for 14.00 a share 2 years later when it looked like they were going bankrupt.
My second great idea was to buy a 5 year equity linked CD linked to telecom stocks. The cd offered 100 percent downside protection with up to a 5 Percent gain depending on the performance of the underlying equities. I put 200k into this investment. In 4 years I’ve collected a grand total of $2500. in earnings.
Where were you and this site 18 years ago!!!!
Thanks, Bill
Wow Bill!
And I feel bad having to sell our 2nd home/lake house to finance their education! At least you have the 200k in the CD still….more than most people are saving I think.
No doubt Chris. Our family is truly blessed.
Thanks, Bill
Ha! Man, imagine if you put the $200,000 in Amazon and let it ride instead.
Ah, too bad we don’t have a time machine to make better investment decisions.
I can understand why you invested in the principal production with a $200,000 investment. But yeah, that Return is not so good. If it was an annual return that would be a different story.
I love that you seem to exclusively use pictures of W&M for college imagery. Hark Upon the Gale!
Only the best!
Living in CA, I opted for the NV 529 plan through Vanguard as well.
The maximum for Vanguard 529s is $370,000.
I live in CA and chose the NV 529 Vanguard plan as well. My understanding is that the California state limit for contributions to 529’s is $370,000, correct? (Even if you chose an out of state plan). I believe each state has it’s own limit, not Vanguard or the plan you chose.
Somebody please correct me if I’m wrong.
Thanks.
Let’s say your state’s max contribution limit is $300K and you reach it. Then, the stock market pulls back and your account dips down to $250K. Can you start adding additional money at that time until you reach $300K again?
Yes I believe so. Just imagine if the account goes down 99%. Of course you should be able to contribute more because you don’t have enough to fund tuition anymore.
Great write up on something I’m super not familiar with. I’m single with no kids, but currently dating someone with a young one and it’s interesting to see what I may be getting into to ensure their success.
Also, if you are flush w cash come time to pay for education, just pay out of pocket and let the 529 ride … it could end up funding generations of tuition that is passed down tax free.
I wonder how long traditional higher education would be really around with the internet and the current state of our education system. Someone said 529 embellishes the difference between the poor and the wealthy.
Paying tuition direct to university doesn’t effect gift limits or lifetime exemptions.
My son is 2 months old and I just opened a UTMA. I can’t see myself paying 200k for College and I prefer the flexibility. If he is really smart he will get a scholarship, if he isn’t a good student, 200k for private college isn’t going to fix it.
Best thing you can provide is a family business and/or connections, aka Trump, Kennedys, etc. Or jump start into family business, law, medicine, accounting, real estate..
And some states starting to offer free college (NY)
Great write up. Thanks!
You should only contribute a maximum of $14,000 a year. Anything more than that involves filing a …
For couples, can we do $28k/yr?
Yep!
Without triggering any yearly gift tax exemptions you can put in $14,000 per person per year or $28,000 per couple per child.
You could also give $14000 to grandma and grandpa who just happen to contribute another $28k to Junior as well. As long as you have trustworthy people to give money to you could add a lot more to your kid’s 529 plan without hiring the yearly limit. Step doctrine might be debatable though.
Tom @ HIP
I’ve always contributed the max ($14k per year) to my now 5-year old’s 529 plan. I did this in years it was really hard to do, and in years when it was a little easier. The hardest is when you pay for expensive preschool/day care (in order to work) and max out the 529 plan, on top of retirement accounts and other life expenses. I sure don’t regret it, though, as it feels great to know that if anything happens to me, my son can at least go to our public state school without debt. Now if his expenses go up as he gets older, or if I decide to retire early and I have to cut back on 529 contributions, it’ll be just fine.
I invest in the NYS 529 plan as I live here and get the tax deduction. It is run by Vanguard so I get low cost index funds. I’m using the age-based option which has 3 choices (conservative, moderate, or aggressive). I originally went with aggressive but read a post on the Finance Buff who wrote that age based funds might be overly aggressive since the timeline is shorter (compared to retirement). But then I also read on I think the White Coat Investor who said that he was fine with it being aggressive since he wasn’t solely relying on the 529 to fund college or that if there wasn’t enough, then the kids would have to figure it out by themselves. Something like that…I don’t recall exactly. I considered moving back into the aggressive option but not at this point as it seems everyone is waiting for a pullback in the stock market. What are your thoughts? How does the fund you chose rebalance as your kid gets closer to college age?
Andrew, curious to know what is the exact deduction you get in NYC? It applies only for NYS residents if you go the NYS 529 plan? I’m bummed California doesn’t have any deductions.
My thoughts are to invest in tranches at current levels and invest closer to the way you’d invest your money since it is your money you are putting in and your thoughts you’ll have to deal with if bad things happen.
BTW isn’t White Coat Investor a doctor? I’m not too familiar with the him or his site. I’ve done tons of research on health, weight loss, joint pain, chronic back pain, and now eye development and I’m wondering maybe there’s an opportunity to expand a Health/Spiritual wellness category on FS. Thoughts?
Yea, it is only for NYS residents who use the NYS 529 plan. You get a deduction for your state income tax. Surprised California doesn’t have a deduction being that it’s so highly taxed. You guys do have a great state university system.
I’d be interested on your thoughts on health and spiritual wellness. I’m sure most readers are here for the finance stuff but it’s fine to mix in other topics too.
Annual contribution limit — it’s important to note that the annual contribution limit is actually $14,000 per parent of the child, so the annual limit is actually $28,000.
We opened up two 529 accounts in our home state of Georgia for our two children. This year Georgia doubled the amount you can deduct to $4,000 per beneficiary. Every little bit of tax savings helps. As you mentioned, my greatest concern with overfunding this account is reduced financial aid.
Georgia is so awesome for promoting education. I’ve always admired the HOPE grant just for doing well in high school! Here’s the program in a nutshell.
12 eligible program areas:
· Certified Engineer Assistant
· Commercial Truck Driving
· Computer Programming
· Computer Technology
· Diesel Equipment Technology
· Early Childhood Care & Education
· Health Science
· Industrial Maintenance
· Movie Production/Set Design
· Practical Nursing
· Precision Manufacturing
· Welding & Joining Technology
These industries have been designated by the Governor’s office as some of the most in-demand trades in the state. They’ve decided to focus on where the jobs are.
What you need to apply for the HOPE Career Grant:
You must qualify for and be receiving the HOPE Grant (the HOPE Career Grant is a separate deal). To qualify for the HOPE Grant you’ll need the following:
* Meet HOPE’s U.S. citizenship or eligible non-citizen requirements;
* Be a legal resident of Georgia;
* Meet enrollment requirements;
* Be in compliance with Selective Service registration requirements;
* Meet academic achievement standards;
* Be in good standing on all student loans or other financial aid programs;
* Be in compliance with the Georgia Drug-Free Postsecondary Education Act of 1990;
* Not have exceeded the maximum award limits for any HOPE program;
Program Eligibility
Full-time enrollment is not required and students are not required to graduate from high school with a specific GPA, however, they are required to have a postsecondary cumulative 2.0 GPA, at certain checkpoints, in order to maintain eligibility.
The two grants together will cover all tuition in the aforementioned programs. Remember, this is for tuition only. Students will still be responsible for student fees and any necessary equipment.
HOW TO APPLY
Apply for the Free Application for Federal Student Aid (FAFSA) or complete the online Georgia Student Finance Application (GSFAPPS).
Talk about forward thinking!
It is a great deal for GA residents. Many friends and co-workers kids already take advantage of this. To think, all funded by revenue from the Georgia Lottery. Too bad more states don’t offer this great incentive.
I have relatives in GA who mention that there’s also a spillover effect from the GA Hope scholarship in that neighboring state flagship universities, which used to get a lot of GA students, now essentially match the amount of tuition waiver the student would have gotten at UGA or GT if instead they do decide to go to Alabama or USC-Columbia, Clemson, Auburn, etc.
Curiously (to me, anyway), they said there’s not a similar effect at UF or FSU.
We purchased a summer/lake home 18 years ago with the plan of selling it for our college costs for our 3 kids ages 18, 14, 13. We also opened up 2- 529 plans for each kid- we use Fidelity as one of them as well as Michigan. Both plans have done great obviously given the last 8 years of market gains. We are in the process of selling our lake home to cover all of our kids’ costs along with their 529 balances (private or public colleges). They don’t want to go to the lake house anymore. I am curious though…what is the average 529 balance per Fidelity or Vanguard- do you know? It was such a great investment tool for us! But have seen many couples not so smart with their savings for college.
I am wondering that with the costs of colleges and universities skyrocketing if more than the 300k will be needed to fund a child’s education. If investments and growth are maxed out, then is there any penalty for growth beyond the limit? Besides tuition, do you know what other expenses qualify for use by the 529? For example, how does one use their 529 to pay for off campus housing or food expenses? ( sorry if this is an elementary question)
Amy-
Going through this now with my 18 year going off to college- we are using her 529. You pay for tuition, computer/software, dorms, but you cannot pay a 3rd party housing company. It has to be a university dorm to receive the 529 payment. You can be reimbursed from your 529 if you pay for off campus housing out of your own pocket. Many 529’s offer a direct payment/online to the university which makes it super easy.
Thank you Chris! That’s very helpful. Do you know if there is a penalty or what happens in excess of a 300k limit ( if we ever get there) ?
No, I do not…I never got to the 300K max. We had a summer home we sold to help cover part of their tuition costs.
The penalty is the estate tax rate of 40% or so.
Let’s say the 529 max is $300,000. You contributed $200,000, and the market grew it to $300,000. It can grow to $500,000 on its own, but you shouldn’t contribute more to it because of the estate tax.
Just think: Number of years to college X $14,000. You’d be hard pressed to get to the max by contributions alone.
But suffice to say we could use any accrued appreciation beyond 300 K without penalty as long as one doesn’t contribute after the 300 K limit is reached ?
I have read many of your posts financial samurai and I just want to thank you. :)
Very informative. What is the advantage of using the 529 plan vs an IRA? I know the contribution limits are much higher with the 529, but an IRA seems to provide more flexibility.
IRA is for you that can’t be touched until 59.5 without a 10% penalty, although education is an exemption. The 529 is specifically for higher education. I strongly recommend folks not co-mingle i.e. use an IRA for retirement for your child’s college education.
I suggest contributing to both, and your 401k if possible. Laser focus your savings/investments for specific purposes. It just takes time to set up.
You can take a qualified distribution from your 401k without incurring the 10% fee. So would the better strategy be to max out retirement accounts and only take out as much as needed? You would still be subject to normal taxes unless you are tapping into Roth 401 or IRA accounts.
https://www.irs.gov/publications/p970/ch09.html
Great call. Here’s what it says:
Qualified education expenses. For purposes of the 10% additional tax, these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.
In addition, if the student is at least a half-time student, room and board are qualified education expenses.
The expense for room and board qualifies only to the extent that it isn’t more than the greater of the following two amounts.
The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
You may need to contact the eligible educational institution for qualified room and board costs.
*********
I just strongly believe one should use their IRA to save for retirement only. Don’t touch it for other stuff. That’s when people start getting in trouble and end up at 60 wondering where their money went.
Related: Only Petulant Fools Borrow From Their 401k
I think there is an exception for distributions used to pay qualified higher education expenses so you can avoid the penalty. However, I think that the withdrawal may be counted as income for FAFSA purposes.
Well written and informative. Thanks Sam. I used Louisiana the last 2 years because it provided a $100 supplement to my son’s account. Now I am in Cali and leaning towards Vanguard funds through Utah.
My only counterpoint is that if your child decides not to go to college (despite all of your influences) then the money can not be used for his/her future endeavors. I have a colleague who had saved over $100K and then his son dropped out of college and never went back to any trade school, etc. He took that money out as a penalty. Now for his younger kids he is just saving in a taxable account. Sure it is not tax advantaged, but there is more flexibility.
For me, it will be a combination. I am contributing small amounts into my son’s accounts, paying off my own school debt, and then saving a small amount in taxable accounts (under my name for now).
I wonder why your colleague didn’t just roll the 529 over to one of his younger children instead of incurring the penalty? We’re currently struggling with how to balance wanting to maximize time in the market vs. over-contributing for our 1.5 year old son. We figure we can roll any excess funds down to our children’s children and use the 529 as part of our estate plan. It’s a little risky and assumes a lot about what his life will look like (i.e., his own children), but if we have multiple children, the plan becomes more solid.
Sam, congrats on your son! I found the first few months to be difficult due to the sleep deprivation, but it just keeps getting easier and more fun. Hang in there!
Thank you Abby! A parent’s worry never goes away… or at least that’s what every single parent has told me :) I’ve spent hours and hours reading, talking, watching videos of presentations about eye development as he might have issues. But there are solutions to make his eyes better and I’m hopeful!
And I know that at the very least, I can provide him tons of love and attention as a SAH parent and at least not let him worry about the financial stuff. Least I can do!
He slept 6 hours last night… a record so far! Been only doing 1-3 hours a time. Yay.
I’m sure you’ve already found a REALLY good doctor there. I learned the hard way with that. Don’t think doctors have all the answers & don’t be afraid to question them or find a specialist- which I’m sure you have. You will be a great dad- don’t worry so much! Small kids…small problems is really the truth.
I planted a good two or three opinions and then make the best decisions possible when the time comes to make them. There are two daughters I want to see, one in San Diego and another in Ohio. I’m thankful at the very least that I have the funds necessary to go visit them and not stress about money .
Sam – this is really helpful! I opened up a 529 plan recently for my future kids but haven’t actually gotten around to contributing yet. Great to see all of this info in an easy to read format so thanks a lot for putting this all together. My parents were generous enough to cover half of my college costs but I was still left with $75k in debt. Would love for my kids to not have to worry too much about debt and start fresh at 22!
We live in Ohio and have the CollegeAdvantage plan the state offers setup for our daughter. When I enrolled in it years ago, it was a sound option (still is pretty good on the list you have) and it gives us the state tax break, which is nice but not worth as much as a federal break would be.
I have 100% in the Vanguard Aggressive Age-Based Portfolio: Vanguard Growth Index Portfolio and contribute a small amount to it every month.
Although it’s a pretty good plan and idea, I would actually prefer some flexibility. I read a great article recently about paying your kids (around 7 or older) a fair salary to do work they’re able to on your rental properties and putting their earnings in a Roth IRA. If the salary is low enough for the year, there’s no taxes to worry about (or even filing).
With the Roth being a retirement account, you don’t get dinged when doing the FAFSA, but you can still pull out all those contributions later without any penalty to pay for school. And if they don’t go to school for whatever reason, they still have a foundation of a retirement account.
I haven’t dug much further into yet, but it seemed like an interesting option.
— Jim
Wow, super comprehensive. I live in Maryland and for what it’s worth, the state 529 website pales in comparison to this guide. Sure they have all this info, but man is it hard to find/read/digest. Not sure how other states are.
What a great investment in your child’s future, Sam. A lot of parents (and aunties, uncles, and grandparents!) want to do this as a way of helping both he student and the family.
I am looking to do this for my two nieces and two nephews. As with all investing, if time is on your side you are likely to come out ahead due to the compounding.
But I wonder what you think about the implications for financial aid. I worry that by putting $ in a 529 in the student’s name that it will make them less eligible for school based grants. Could there be an argument that it is better to have the money invested on an account in my name, and I can subsequently pay part or all of the tuition at the time it is due?
Alternatively, I could wait until the dear nieces and nephews graduate and then surprise them with a payoff of the loans (that way they still have the motivation while they are in school!).
Awesome write up and glad to know you are in favor of the 529 and not something like prepaying or a Coverdell.
I actually used Wealthfront at first because the contribution limit for Vanguard was $3,000 which I didn’t have at the time. Probably not a problem for you ;) I liked Wealthfront but you can get basically the same thing with Vanguard for about 0.25% less in fees per year. Once I got to $3,000 the transfer from Wealthfront to Vanguard was super easy.
Only thing that concerns me with Vanguard is when using the aggressive target date model it is 100% stock for the first few years.
Should probably mention something about how the funds in the 529 (either in your name or even more so in your kids name) will count against your kid for getting financial aid (FAFSA). I make 6 figures, but also have 4 kids and stay at home wife. My strategy is usually to take advantage of all possible tax breaks, but in this case you also have to consider financial aid eligibility. I just rethought my strategy a couple weeks ago and now think it makes more sense to use all excess cash to pay off mortgage first since that asset along with retirement accounts do not show up as assets for financial aid purposes. If the house is paid off by the time they start college, then that will free up cash to pay for any difference (between tuition and financial aid). Additionally, I could quit work a couple years before they start college and be double sure to get max financial aid. Also, why would you not just teach your kids how to create their own digital empire? Then school become irrelevant. I’ve got a BS Engineering, MS Engineering, MBA, and MS Finance…so maybe not one to talk, but my company paid for all the Master Degrees. Love your site, keep the articles coming. Any thoughts on buying an online business using SBA financing?
Great call. I’m impressed with anybody who can manage to raise 4 kids! Is that right, that your primary residence and your 401k, SEP IRA, Roth IRA etc don’t count as assets under the FAFSA program? If so, right on for using the money to pay down the mortgage, maxing out the retirement accounts AND not work for a couple years before your children go to college if you can afford not to do so. All these things should be done for FIRE purposes anyway.
I definitely plan to teach my son how to write, speak, market, brand, and do all sorts of stuff in the digital media space. Let’s see if he wants to learn! Well done on all your education. I don’t think we’ll be going that route as everything can be learned online for free nowadays. I got my MBA part-time, and wouldn’t do it any other way if I had to do it again.
I’ve added this section:
Does A 529 Plan Affect My Financial Aid Package?
When you apply for the Free Application for Federal Student Aid (FAFSA), it’ll try to ascertain your income and total assets. Logically, the higher your income and higher your assets, the less aid you will receive.
Assets in a 529 plan owned by the student or her parents count against need-based aid, while those in a plan owned by anyone else (including grandparents) don’t. But once grandparents or other relatives start taking money out of a plan to help pay those bills, the reverse is true. The withdrawals can hurt you even more than if the plan was owned by the student or parent for next year’s financial aid package.
The 529 plans owned by college students or their parents count as assets and reduce need-based aid by a maximum of 5.64 percent of the asset’s value. That means if you have $50,000 in a college-savings plan for your daughter, her aid would be reduced by roughly $2,820.
However, if the 529 plans are held by a grandparent, they won’t appear on the FAFSA as assets. Instead, as the money is withdrawn to pay for tuition or other educational expenses, that amount must be reported on the next year’s financial aid forms as untaxed income to the student, and it can reduce the amount of aid by 50 percent.
So if that same $50,000 college-savings plan was owned by the grandparents, and the student withdrew $10,000 from it one year, that withdrawal could increase the amount the family is expected to pay for college (and reduce the aid) for next year by about $5,000.
Therefore, the logical conclusion is to either have the 529 plan under your child or your name to minimize the reduction, or use draw down the 529 plan under the grandparent’s name in the very last year of college.
I had always viewed 529 programs as the best program for funding college as well. However, similar to what you mention above, some college funding experts are now indicating 529 programs are a negative. The logic goes that once you have been accepted into a particular college program, especially private schools, they use the FAFSA needs analysis to see what they need to offer you in grants and loans to convince you to attend their school. When schools see 529 money, they view that as captive money that they are going to get no matter what. The schools then reduce your grants by the 529 money already available to them. A student with no 529 funds that has been accepted will need more grants in order to convince them to attend.
Totally makes sense with your analysis. That being said, you can make gains tax free and if you’re a high income earner your kids are screwed either way on getting aide (outside off merit based scholarships) so if you’re in that boat you might as well get some tax free gains on your side. When I was in college my parents made way too much so aide was out of the question and only merit based scholarships was what I was allowed to chase. I had no 529 but received full rides so it all worked out but just keep that in mind.
Now something you didn’t point out Sam was using the 529 for grad school. Can you just keep money in the 529 and apply it towards graduate school later or do you have to cash it out right away? If you’re 22 and planning for a MBA can you just start your own 529 and put money in there to get tax free gains if you plan on going for the MBA in the 26-30 year range? Always wondered about this one but never bothered to research it, but maybe you (or someone else here) already does know?
Good question on graduate school. Yes, you can use the 529 plan proceeds to pay for graduate school. That helps in terms of excess funding. But don’t go to graduate school just because you have money to spend on it!
How did you earn a merit based full ride and what school?
I feel that no matter what, my income will be too high to get any grants (due you do passive income alone ). All I want are grants, and not loans. And it seems like the grants are mostly based off of merit.
Your primary residence/farm/small business assets are reportable for CSS though.
Sam – Very nice info for 529 plans.
I had Pennsylvania 529 Investment Plans for both my sons that I started not long after they were born. The plan worked great for my first son.
For my second son, it got a little trickier. He had an academic scholarship and he joined ROTC. ROTC pays the university the full tuition even though the my son did not pay full tuition. It made it hard to use the entire 529 for qualified expenses.
One very important point that Sam missed is that you are allowed to withdraw 529 funds up to the amount of any scholarships without paying taxes or penalties. I.E., if you saved $80k in your child’s 529 and they end up getting a $20k/year scholarship, you can take $20k/year from the 529 penalty and tax free. This is a great benefit that really reduces the risk of ‘over saving’ in a 529.
That’s an interesting point. So when you say scholarship, you are talking about a grant, as in FREE MONEY right?
So let’s think about this fun situation: After 18 years, you max out your child’s 529 plan at $300,000. Let’s say he gets a full $300,000 ride when the time comes. I can withdraw the full $300,000 to spend on a new Ferrari penalty and tax free given he no longer has college education costs? Or does the $300,000 Ferrari have to go to my son?
I just reread my first post and realized I mistakingly said ‘tax free’. I wish! Scholarship-matching withdraws are only penalty-free. Scholarships basically turn the 529 into an IRA.
As for who the withdrawals have to go to, it can be either you or your child. This may be one of those ‘Your State May Vary’ rules, so would be worth verifying.
What did you end up using the rest of the 529 money for and did you have to pay any penalties?
I’m just wondering how does one figure out the optimal amount of money to contribute b/c I definitely plan to max out the 529 plan in 18 years, market performance willing ($14,000 X 18 = $252,000 + any appreciation). How would you think about the contribution scenario for those who can max contribute?
I have an 18 year old and we make too much money to get any scholarships/grants, etc. I think you definitely should max out $14K per year for the next 18 years. Most colleges now are about 50K! What will they be in 18 years?!?! You will be so happy you have that money saved because lots of our friends did not…they bought fancy cars and country club memberships- now their kids are limited in where they can go to college.
Which is fine…but like you said- it’s our jobs as parents to educate our kids and let them soar where they want to be.
Most of the money went towards the Room and Board qualified expenses which was a little tricky once he started living off campus. I had to use what the college estimated was Room and Board and use that. Then he went and studied in China during the summer so I could use some for that.
I think I ended paying tax and penalty on around $2000 when he was all done. Not the end of the world.
This is so helpful. Thank you so much for sharing, Sam! Mr. FAF and I haven’t contributed anything to our son’s education plan. I have heard about the 529 plan but didn’t know much detail about it until I read your post.
Mr. FAF hope that our children will get a full ride scholarship to attend college and grad school like we did. But I think we still need to have another plan in case things don’t work out.
Fyi Utah is managed by Vanguard.
I highly recommend the Utah 529 (UESP). I have my daughters’ 529s with UESP – 9 years and counting -, and unless you get a state income tax incentive to stay in your home state, I don’t see why anyone would choose another 529 over Utah’s.
Can you elaborate on why Utah’s 529 UESP? Just several bullet points would be great. thx
Rock-bottom fees, flexible investment options, Vanguard index funds; What more could you want in a 529? You have the 2016 Morningstar ratings in your article above, and although plans pop in and out of the Gold ranking year-by-year, Utah remains a stalwart. To make it even better, they keep lowering their fees as their plan grows.
Derek is right. I live outside of UT but have my kids’ 529 plans in UTEP for the same reasons.
Ditto. Utah is also very transparent and has an easy-to-use website. MAkes sense a state with a large Mormon population would offer a great plan (higher birth rates, culturally a strong focus on education).
Utah used to be the best option (lowest fee, good vanguard choices)– now it is one of the best because other plans have caught up. We’ve been using them for 10.5 years.
Welp…I am bookmarking this for when I have kids. Thanks for a very thorough summary. I was anticipating having to do a lot of research into 529s in the relatively near future, so thanks for doing the hard work for me!
Lol me too Matt! We don’t have kids yet but I see it in other people’s portfolio and their child is only like 3 years old but there’s already 100K in this thing call 529! Wow. I’m like “I know I can Google this but…*never actually does and I flip to Imgur for cat memes instead*”
It’s kinda like Sam decided to hand me a cheat sheet before a pop quiz muahahaha!
Same. I had started to research this but my state (WA) offers a weird prepaid tuition program instead of a 529. I didn’t realize you could sign up for any state’s program… NV’s does look quite nice. Thanks!
Career politicians keep propping up a wasteful education system. A part reason is cause it will give them votes, and another part is spending their entire 30 year careers paid by taxpayers they don’t know any better. The system needs to be split into 2, research and teaching. Teaching needs to die should if fail to deliver on well paying job in the $70-100k range. Every student needs to be measured and tracked for 10 years in their career and pay range starting at age 22 when they have their degree. These studies need to be released for transparency. But then what will all the high school teachers who couldn’t cut it and weren’t intelligent enough to get engineering, computer science, medicine do? Idk. Will they go work at the clothing stores, work at a retail mall?
The market small, medium and large companies are only about skills. Skills beat degrees anyday in real society. Only in bureaucrat jobs do degrees beat market skills. Does your company care that you memorized 4 textbooks on chemistry, biology, history, music, greek? No. Only the government cares. Did NFL players, musicians, celebrities memorized 4 textbooks on chemistry, biology, history, music, greek? No. Your company cares about your network, your ROI, do you have technical know how, how much $ can you make your boss.
Steve,
I am not sure if it is as simple as that. Companies are hiring individuals more so than the government. Most companies DO care about degrees for entry level positions. Don’t get me wrong beyond that first position the case is exactly what you pointed out. However, just because someone isn’t going into a STEM field does not mean they aren’t successful and/or intelligent. I agree education is an extrememly wasteful system but it is propped up by more than a greedy government; there are business owners, a generation that saw college educations as the gold standard and an education system that has not been redesigned in over a hundred years.
I am a huge fan of the VA 529 plan. Plus we get to deduct up to $4k a year for my son. Definitely a worthwhile investment considering how many of my peers struggle with student loan debt. Definitely one of the greatest gifts you can give your son is a debt free start after college.
MSM,
You can actually do $8k a year per child for the VA 529 plan. You and your spouse can each do $4k per beneficiary and deduct that from a joint state tax return. You have to open two accounts, one for each contributor. Baby Widget has this in place. :)
Mr. Widget