Lazy Man and Money

529 Plans: 29 Thoughts for 5/29

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Happy 5/29 Day! Regular readers probably already know that a 529 is a college savings plan. New readers who didn’t know that, just learned something.

529 PlanI first started looking into college savings plans in 2007, when my nephew was born. I wanted to give him a little head start. I loved the idea my gift would be multiplied thanks to the power of compound interest.

Unfortunately college savings plans can be a little difficult for a new parent (or uncle) to understand. This lead to my How to Choose a 529 Guide.

I put in a little money to seed the account and added more on birthdays and holidays. My nephew got himself an awesome little sister, so I opened up an account for her too. Grandma occasionally pitched in some money as well.

Today, their accounts have more than $6,000. More than half of that is from market gains. Hopefully, that will buy a few hours of lecture by the time by the time they are in college.

Nowadays, we’re a little more focused on saving for our own kids. We’ve got some work to do on that front, but we do have $20,000 saved. That’s enough about our situation though. We have my wife’s GI Bill. We’re investing in their education with the best private school in the area, so they better earn scholarships too, right? Finally, we want the kids to have some of their own money for their own education so they don’t skip classes.

In short, there are a lot of ways to save for college. Today we’re focused on 529 plans. Let’s get into 29 thoughts on 529 Plans on 5/29.

1. When money from a 529 plan is used for a qualified education expense, there are no taxes to pay on the investment gains.

2. Unfortunately, it’s difficult to get great gains on a 529 plan since they are typically compounding for less than 20 years.

3. You might be able to reasonably double your money twice in that 20 years. Thus one dollar invested at a child’s birth may be worth four after high school graduation. This assumption uses the rule of 69 with 7-8% investment growth.

4. Thus, if you put one year of tuition in a 529 account at birth, it could fund their entire college education. (Unfortunately, very few people have tens of thousands to invest when a new child is born.)

5. 529 plans are run at the state level. As soon as you are done with this article, you’ll want to look at your own state’s specific plan.

6. Some states give you an extra incentive to open a 529 plan. My state, Rhode Island, gives a $100 grant if you sign up for a 529 plan when your baby is born.

7. I used this idea to help motivate a blogger friend to start a 529 plan. I offered $25 and a couple of other bloggers joined in.

8. Some states allow for a tax deduction or credit for saving in a 529 plan.

9. Some states have better investment options than others. When I lived in California there was no tax incentive for me to invest in the state plan. I decided it was best to invest in Ohio’s plan which had Vanguard funds with low expenses.

10. 529 plans can be rolled over to a new beneficiary such as a child. This can be done indefinitely, possibly creating a family legacy of education funding and compound interest.

11. 529 plan money can be used to buy computers. See this IRS page for more details.

12. 529 plan money can also be used to buy computer software subject to the same IRS rules mentioned previously.

13. 529 plan money can even be used for internet service.

14. 529 plan money can be used for tuition at private or religious elementary or secondary schools.

15. 529 Plans can be used for community and technical schools.

16. 529 Plans can be used for some nontraditional schools such as the Golf Academy of America, the commercial diving program CDA Technical Institute, and the Le Cordon Bleu College of Culinary Arts. Yes, golf, diving, and cooking can qualify.

17. 529 Plans can be used for online schools.

18. 529 Plans can be used for hundreds of international schools. Check with the government searchable database first.

19. 529 Plans can be used for online schools. Again, check with the government searchable database first.

20. There’s a limit of $10,000 per year for elementary and secondary use.

21. If your state has a tax deduction for 529 plan contributions, you may want to funnel money through the plan to save on your state tax.

22. If the beneficiary gets a scholarship an equivalent amount of the money in the 529 plan can be used penalty-free. However, taxes on the gains will apply.

23. Alabama and Illinois have a 529 Rewards Visa card where you can earn 1.529% rewards on your spending. A small annual fee may apply. As always, it’s best to pay off your credit cards every month to avoid the huge interest charges.

24. One of the best ways to grow a 529 is simply to create an automatic monthly transfer from your income. This “paying yourself first” creates forced savings.

25. A wealthy relative can use a 529 plan to circumvent the gift tax by “superfunding” 5 years of contributions ($70,000) in one year.

26. Almost 300 private colleges and universities belong to a Private College 529 Plan. It’s the only 529 plan not run by a state and it allows you to lock in tomorrow’s tuition at today’s rates. It’s not an investment.

27. However, if you plan to contribute to the Private College 529 Plan and go to a school that doesn’t participate, you may have done better investing in a regular 529 plan.

28. It’s possible to combine a Private College 529 for tuition and a regular 529 for other expenses such as room and board.

29. As 529 plans are intrinsically linked to taxes, please consult with your tax advisor before implementing anything mentioned here.

If you’ve made it through all 29 thoughts, I hope that you’ve been inspired to investigate at least a few of them further. Let me know in the comments if you have followed any of these down the rabbit and what your experience with 529 plans is.

Past, Present, and Future

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I’ve never liked click-bait titles. You know, those kind of titles that end with, “… and you won’t believe what happened!” I am almost always disappointed because the “unbelievable thing”, wasn’t so unbelievable.

So today, I’m going to do the opposite and start with the most boring title I can think of. By setting the expectation low, I can’t help but surpass it, right?

We’ll start with:

The Past

It’s Memorial Day in the United States. For many it is a time to reflect on the people who gave their lives for our country. For some it is an excuse to drink beer and eat burgers. If you are in the later group, I hope you spend some time reflecting on why we have the holiday. Having an appreciation might make your beer and burger taste a little better.

It’s tempting to write a whole blog post about Memorial Day, but this site is about personal finance. There are some great military blogs and news sites that will do a far better job than I will

The Present

Long weekends are great for my dog sitting business. It was looking bleak for most of the month, but in the last week, we booked up completely. I even had to turn away a couple of dogs. (That’s always a heart-breaker.)

We’ve had a lot of rain this weekend, so I haven’t gotten out much. I’m a long ways away from The Shining territory, but I am starting to feel a little trapped. My 4-year old suggested that we play memory for Memorial Day. I liked his logic. The four of us played and my wife cheated by using her photographic memory. She got twice the matches I did. I got twice the matches my 4-year old did. And the 4-year old got twice the matches my 3-year old did. Sounds like an SAT problem.

The rainy Memorial Day weekend is significant for our local economy. We get a ton of tourism and Memorial Day is the unofficial start of summer. (Shop owners can in some ways say, “Happy Memorial Day!” and not have it sound weird. This is when they make most of their money.) With the rain, people didn’t come and didn’t spend money. I’ve seen restaurants gut their staff after such a hit.

The Future

Today is also 5/29. For personal finance blogs like this one, it is a significant date. It’s an annual reminder to those of us who have kids that we might want to contribute to their 529 Plan.

If you are new to 529 Plans they are tax-advantaged way to save for college. They almost work like Roth IRAs where the money grows and comes out tax-free. That’s a decent tax perk. In my state, Rhode Island, we can also deduct up to $1000 from our taxes per year. Since we are saving for our kids college anyway, it makes sense to do it this way.

It seems that Rhode Island has another tax perk that could prove very interesting. It seems that a couple is allowed unlimited carry over of this deduction. I understand this to mean that if we put in $40,000 today we could deduct $1000 off our taxes for the next 40 years. I need to consult my tax advisor on this to make sure I understand it correctly.

If that’s true, it is not too shabby to have that tax deduction hanging around. Of course, who knows if we’ll live in Rhode Island or be alive in 40 years. The only downside is that a $1000 state tax deduction may only amount to a $40-60 savings each year at Rhode Island’s correct tax rates. Hmmm, that’s not too exciting after all.

It is a little dated now, but 10 years ago, I wrote a brief guide to choosing a 529 plan. The main ideas are still helpful, but the specific numbers for the states probably have changed.

I found that if your state offers one with some tax deduction (like Rhode Island), usually that’s the way to go. If your state doesn’t (California didn’t when I lived there), it may be best to explore another state’s plan. Back in 2007, I decided that Ohio’s was the best fit for us. I still have a couple of accounts with them today.

However, you choose to spend today, I hope it is meaningful to you.

Happy 529 Day!

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May is known for one of the best date puns ever created.

No, it isn’t that silly May the Fourth Star Wars day.

Star Wars day is extremely unlikely to put a dollar in your pocket. (Unless you are a Disney investor like a few of my friends.)

The best date pun in May is 529 day… which is today: 5/29.

Regular readers of personal finance blogs like this one know that 529 refers to Section 529 of the U.S. Internal Revenue Code that allows for a tax-advantage when investing for qualified education expenses (usually college).

That means that parents can at least get a small break when dealing with enormous, exploding college tuition prices.

It’s also a well-timed reminder that now that tax season is over, it can be a wise move to start putting money into a 529 Plan. I started a 529 plan around 2007 or 2008 for my niece and nephew and one for each of my own children in 2012 and 2014.

It wasn’t exactly easy picking the best plan either time. In fact, it reminds me of the NFL playoff rules where you get to the Nth tie-breaker and it’s literally a coin flip that decides a team’s entire fate.

To help people pick the best 529 Plan, I wrote this guide: 529 Plans: How Do you Choose?

Since 529 Plans are very state-specific, that should at least be a good place to start. Some of the specific data on plans are a little dated, but the concepts stand strong today.

Hopefully, today, you are enjoying a hamburger, hot dog, or whatever it is you like when you get to take a little time off of work. Let’s put in a coupe of extra minutes to chew on the financial future of our children as well.

And certainly, please don’t take my 529 Plan away.

Let’s Discuss Obama’s 529 Taxation Plan

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I’ve been reading a number of articles on President Barack Obama’s proposal for 529 plans. Some of the articles I’ve read include: The Slate, Vox, and Market Watch.

I watched the State of Union in part to hear from the horse’s mouth what this was all about. Unfortunately, the address was so general covering so many topics that it wasn’t specifically addressed.

The proposal, as best I can tell, is the following:

Currently, savings for college in 529 plans are not taxed when they are withdrawn. The proposal is to tax 529 plan withdrawals as income as using that money to provide free community college. I understand that this taxation was the way it used to be in the past. In that respect, I can’t say it is a new tax. However, it feels new to me, because I was too young to know or care about it the first time around.

The Slate article thinks this is a great idea. The reasoning was that the “47 percent of families that had [these college savings plans] earned more than $150,000 per year.” The author concludes, “I generally don’t think that our higher education policy should be geared toward helping families that earned $150,000 or more send their kid to the most expensive possible school.”

I thought that was an interesting way to spin it. There’s nothing anywhere in 529 Plans that discuss the most expensive possible school. I’m not sure that anyone would use that logic in choosing a school. I would imagine that people who make $150,000 or more are fairly intelligent and would put more thought into college education than just, “What is the most expensive possible school? That’s where junior is going!”

So let’s look at this logically for a minute.

Studies show that 36% of Americans have less than $1000 in savings. Let’s presume that they aren’t socking money away for college. These people for whatever reason (either hardship or just their own spending habits) don’t appear to be savers.

Next up you have the people maxing out their retirement accounts. Personal finance experts correctly point out that you can’t get a loan for retirement, so it wisest to always save money there first. Student loans will be an option for children. Presumably a large number of people make the smart choice here and funnel money towards retirement.

So who are the 529 Plan savers going to be? They are most likely to be the educated people who have already maxed out their retirement tax benefits. That’s likely to people who have higher incomes. I point this out, because it shouldn’t be a surprise that many of the people saving in these plans have more income. It’s the nature of the beast when it comes to saving for college.

Here’s the thing that really irks me though… the change to tax withdrawals at ordinary income sends the message to people, “Don’t save money for college.” It would kill 529 Plans. Why would anyone put after tax money into an account that is subject to withdrawal penalties and taxation at ordinary income in withdrawal? I could open an account with any brokerage and put after tax money into a balanced fund and withdraw it at a (very likely) cheaper long-term capital gains rate.

A 529 Plan would offer worse taxation and the potential of penalties. Some states have tax incentives, but most of them are very minor and certainly wouldn’t match with the negatives.

The other thing that irks me is that it feels like a penalty to those who do right thing and live within their means, plan ahead, and utilize a tax-benefit that can help them give their children something they didn’t have. It might take away the chance for those blue collar workers to send their kid to Princeton. Meanwhile, the high income people are going to have no problem affording it. Thus the rich get richer by being able to send them to the best schools and the lower class loses an avenue to rise up.

I don’t think the 529 Plan is the biggest tax break in the world. It essentially puts saving for college on same footing as the Roth IRA when it comes to saving retirement. Changing the 529 Plan taxation to fund community college for all feels like changing the Roth IRA taxation to fund Social Security. I’m not against community college for all or Social Security. I’m for incentivizing people to save money for college and retirement.

I’m not one to just complain, so I’ll take a crack at a solution. How about a Free Federal Accredited Online College (FFAOC)? Why can’t the government make a University of Phoenix Online and offer classes and curriculum to everyone free of charge? Instead of trying to come up with the money to physically send tens of millions of kids to thousands and thousands of different college for two years, do what scales. Build and maintain one system that can support tens of millions students.

Please don’t give any Obamacare technology jokes, hundreds, maybe thousands of companies in Silicon Valley scale at this level. The most question I can think of is whether companies would take the FFAOC degree. That can easily be answered by having a grading system to go with the degree, just like we have now with graduating Harvard Cum Laude. The classes could be as easy as any community college or as difficult as Stanford depending on how the government designs the curriculum. Personally, I’d like to see people have all options.

Is this a perfect solution? Of course not. People shouldn’t spend all time learning in front of a computer. It clearly wouldn’t duplicate the experience of an on-campus university. However, let’s remember that this is a free option. It’s a way for anyone with a computer and an internet connection to get a college-level degree in their spare time. If you want to go to community college, you can still pay for it. If you want to go public or private 4-year schools you can pay for that too.

If the government did create a FFAOC, I think many might prefer that over traditional colleges. When I was in high school, I was given the opportunity to take a class for real credit at a local university. I jumped on the opportunity. I would hope that if my sons have the same option to take some free college classes online and get credit they jump all over it as well. It would be a really interesting way to solve the student debt problem in the country. A majority of students might find that the FFAOC fulfills all their needs. Others might find that the FFAOC can give them some credits so that they can get a degree from MIT in 2 or 3 years.

So let’s create a system that scales and boosts the education for every American who wants to do the work… and let’s keep incentives in place for those who want to save money to pay for premium education.

Exploring College Savings Goals

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College Savings Goals (click for larger)

A few years back, I wrote a short guide to 529 Plans as I put some money away for my niece and newphew’s college savings. The plan I chose was Ohio’s CollegeAdvantage, because California didn’t offer any state tax breaks and the investing fees with CollegeAdvantage’s Vanguard funds were microscoptic. I’m a little behind on reading the newsletters, but I noticed an interesting thing in the Q4 edition of their 2013 newsletter (click that link to open it up in a new window, so you can follow along).

It lays out two facts that I found interesting. The average savings goal for parents is $38,953 for one child, yet the average savings balance is “only” $18,013. This sounds like a big problem doesn’t it? In some ways yes and in other ways no. Sometimes the numbers are tricky.

First, the average savings balance is going to include many people who just started to fund their accounts. It’s not the average account for 16 year olds. If you look at the average age of the children in the accounts, it would seem to be 9 years old (the 1 year olds offsetting the 16 year olds)… which means that people are almost on track for their goals with $18,013. In fact, I’d bet the average age is closer to 6. 529 plans have only been around for 18 years (started in 1996) and I’m betting that they are more popular today than they were then. So maybe we are more on track with our savings than we think.

Additionally, the average savings account balance includes people like me. Sure, I’m probably the rare uncle who opens up 529 plans, but these accounts are intended to be supplemental to their parents’ own savings. I certainly don’t have the goal to save nearly $39,000 for each of them. I even opened up an account in my own name to squirrel away a little money for a future son (and now I have two). However, since I’ve moved to a state that offers a tax benefit, I’ve opened up another 529 plan… and I’ll be opening yet another when my new son’s paperwork comes through (Social Security number, birth certificate etc.). I’ll have 5 different 529 plans all nowhere close to $39,000… but it is by design.

The other point this short chart makes is that the $39,000 amount is only likely to last through 2 years at a public university. One could make a case that the goal is set too low to begin with. On the other hand, there’s no rule that says that parents have to put up 100% of their children’s college education. In fact, I think the children might get more out of college if they have some “skin in the game” by paying for a share themselves. However, this is a whole other discussion where I don’t think there are any right or wrong answers, just people’s personal preferences.

My goal with highlighting this information is the importance of thinking critically. Sometimes you are presented with information that may seem alarming, when it really isn’t.