Episode 4 - Education Funding Decoded: A Deep Dive into 529 Plans
Unlock the secrets of saving for college and master the intricacies of 529 plans with this insightful podcast. Ensuring your child's future is secure is a top priority, and we're going to guide you through the complicated maze of college savings. You’ll learn:
The two main types of 529 plans - savings and prepaid,
Tax benefits of contributions,
What to do if there are excess 529 plan funds,
How to fund private K-12 expenses, and
Alternatives to college saving plans.
Links
https://www.savingforcollege.com/
Kiplinger article - A Deep Dive into 529 Plans
Connect with Deb
Website: WorthyNest.com/podcast
Submit your family finance questions to podcast@worthynest.com
Get your FREE family finance starter guide
Pick up a copy of my book, Redefining Family Wealth
Full transcript
Deb Meyer (00:02.326)
Hello and welcome to Beyond Budgets®, episode four, where we're gonna talk about saving for education. It's a big, big cost for many parents and I want to talk through some of the specifics on 529 plans, which are college savings plans. There are also other types of accounts you could consider if you're not quite sure if your son or daughter is going to college. We're even gonna touch on some of the competing savings priorities and whether you should even start to save for college right now or if you need to be focusing your attention elsewhere.
So again, anything in this episode is educational in nature. It's not specific to your unique circumstance. I just want to emphasize that I'm going to give as much information as I can, but it would really be more beneficial if you were needing specific guidance on your particular situation to seek out the guidance of a financial advisor, and more specifically a Certified Financial PlannerTM. All right, let's jump in to competing savings priorities. For a lot of parents, we want the best for our kids. We want to be able to provide every little luxury in life, not only as they're growing up, but also to be able to fund most, if not all, of their college education if they decide to attend college.
And for many parents, we're working hard, we're saving diligently. For some of us, we're stuck in cycles of debt or we're having difficulty just making ends meet on a month to month basis. Others have been able to save, we're contributing to retirement accounts. We have extra cashflow at the end of each month. Those are two very different situations. So if you're faced with a lot of debt payoff, you have high-interest debt, like credit card debt, or your own student loans that you're still paying off from college, probably not gonna be in the best position to be starting to save for your children's higher education costs. But if you are regularly contributing to retirement accounts, you at the minimum are putting in enough to match whatever your employer's giving you, that's wonderful. If you have an emergency fund or a cash reserve of at least three months of living expenses.
Deb Meyer (02:20.51)
Again, that's going to be another great avenue that means you're better prepared to start considering saving for higher education costs. When we talk about saving for college specifically, one of the items that comes to mind as kind of a gold standard would be the 529 plan. And the 529 plan is great because depending on the type of plan you have, you can possibly have a tax deduction.
Again, it depends on the state that you live in and whether they offer tax breaks for those contributions. But then also it has the benefit of growing tax-free. And then if it's used for higher education costs, qualified higher education costs, you will be able to withdraw that money tax free as well. So you're getting a really nice tax advantage for any kind of 529 plan contributions, savings plan contributions.
And before I go any further, I just want to specify that there are two different broad types of 529 plans. There are the savings plans where I was talking through some of the benefits just a moment ago and there are also the prepaid plans. Those are a little bit more specific where you have a very concrete goal and you want to save specifically towards that particular university. If you're not quite sure, you need a little bit more flexibility, going the 529 savings plan route is better because it does give you maximum flexibility in terms of where your son or daughter might use those dollars. And it doesn't have to be used on a four-year educational institution. It could be a two-year associate's degree or it could be trade school. So there's some flexibility there with the 529 savings plan. And I'll dive into both a little bit.
So let's talk about the prepaid plans. Within the prepaid plans, there are kind of two options. There's one if you know your son or daughter wants to go to an in-state public university in your home state. So let's say you're a resident of Alabama and your son or daughter wants to go to University of Alabama. You could, if let's say that son or daughter is 10 years old right now, you could lock in the tuition at today's rates through a prepaid plan for University of Alabama and then know that even if the tuition rises and is now double by the time your son or daughter goes to University of Alabama, that tuition you already locked in through the prepaid plan. You're essentially hedging against tuition inflation. If tuition increases 8% per year over the next eight years, now it's a pretty big chunk of change. And again, you're getting the benefit
Deb Meyer (05:12.638)
while your son or daughter is young. Now let's say you know they don't want to go to an in-state public university but they're dead set on going to some kind of private college. They're not quite sure what state it's going to be in but they definitely want to go private. There is a different kind of prepaid plan called Private College 529 and it's designed specifically for those families who want to send their kids to a private school.
So this would not be University of Alabama. We'll take another example like St. Louis University, which I went to. And if my son or daughter at age 10 knew they wanted to go to St. Louis University at age 18, I could lock in the tuition today, put it in that Private College 529 plan and have it grow over time. So it's ready, regardless of what the tuition increases are along the way.
With these prepaid plans, if you have a son or daughter that's on the younger side and there's several years for that tuition inflation to creep up, this could be a really good option if they're 100% certain that's where they want to be going to school. Now, I don't know about you, but I have a 10-year-old and my 10-year-old has no idea if he wants to college, where he would want to go to college. So being realistic, the likelihood of your son or daughter knowing exactly what they want to be doing at age 10 or even 14 is slim. My oldest is 14. He says he wants to go to one particular school, but I don't know. I think he could change his mind over time, especially given that he's only visited that one school's campus and hasn't seen other campuses. Again, with the prepaid plans, the real benefits are that you're paying for tomorrow's tuition and you also have a tuition inflation hedge.
Now, if we were to go the other route with the 529 savings plans, which are more flexible and give you options in terms of where your son or daughter attends school, I think an excellent resource to consider is savingforcollege.com. And I'll put links in the show notes. So I'll link to Private College 529 and savingforcollege.com.
Deb Meyer (07:33.334)
The cool part about savingforcollege.com is they will let you compare plans. Let's just say you are a resident of Missouri. I have a lot of clients there because that's where I used to live. So as a resident of Missouri, there's a special tax benefit when you're making a contribution to a 529 plan. If you're single up to eight thousand dollars per year of 529 plan contributions, if you're married up to $16,000 per year of contributions, you can get a nice little Missouri tax break on your Missouri tax return for making those contributions. Now, if you decide that you don't want to do the Missouri MOST Plan, which is the in-state plan, let's say you've researched on savingforcollege.com and you found a different plan that you like better from an investment option perspective or fee expense, those kinds of factors.
Let's say you decide to open a New York 529 plan. Well, obviously New York's a different state, but the nice part about Missouri specifically is they're one of a few states that allow you to take that Missouri tax break, even if you contribute to an out-of-state plan. So I have some clients that are Missouri residents.
They go and open a New York 529 plan because they like the investment options and fees a little bit better in that plan. And then they still get to take that Missouri tax break on their tax return when they file each year. That's just food for thought. Missouri is one of those states. There are a couple of others. I don't know each one off the top of my head, but you would be able to go to savingforcollege.com and even enter your state of residency and kind of see what the different options are in terms of tax breaks and things like that.
If you contributed to an out-of-state plan or stuck with your in-state plan, how that availability is affected. Right now I live in the state of Florida, so we don't have state income tax. And for us, it doesn't really matter what kind of 529 plan contributions we make because we're not going to get any specific state tax benefit from making those contributions.
Deb Meyer (09:51.206)
Nonetheless, I still encourage myself and other Florida clients, if we're trying to save for college expenses, we can still make contributions to the 529 plans. We're just not going to get a specific state tax break. But again, since we're not paying income tax here, it's not that big of a deal. Tennessee is a similar state where there's no state income tax. So obviously there won't be any kind of state tax deduction. Texas is another state just like that.
I don't remember every single state off the top of my head, but that would be available on savingforcollege.com where it would show you if you're getting a state tax break or not for the contributions. All right.
So let's talk a little bit about the tax benefits after you make the contributions. Number one, the growth of that investment is tax-free. So let's say you put $10,000 as a lump sum amount into a 529 plan and your son or daughter is five years old.
Well, let's say by age 12, that money has now doubled. So you put the initial $10,000 in, it's now up to $20,000. And then let's say by the time they go to college, age 18, it's now worth, let's say, $35,000 or $40,000. Well, your initial investment was only $10,000. And the nice part is when you take out that contribution, that 10,000 plus all the appreciation, as long as it's for qualified higher education costs, you're not paying a dime on that distribution. So you get to take out that full 35,000 or 40,000, whatever it grew to, and use that for college tuition. It's a pretty sweet benefit if you think about it, especially if you're able to start saving when the kids are young.
The other thing I wanted to mention on the 529 savings plans is that they are subject to investment risk. So if the market tends to be doing well, usually the value of those accounts is gonna go up over time. If the market's not doing so great, the value could decrease. If you find yourself in a moment where, okay, the economic outlook isn't looking very good and your son or daughter needs to go use these funds for college pretty quickly here, you probably wanna move towards safer investments like cash and fixed income.
Deb Meyer (12:13.454)
And again, you have complete flexibility with a lot of these 529 plans on the investment selection. They have different age-based options where they'll automatically adjust it for your child based on his or her age, whoever the beneficiary is, the person that is benefiting from the account. You can tie the investments to their age or you could specifically select certain positions if you're more astute on the investing side.
The only caveat with that is you have to closely follow it. And if you do see some change in market activity, start to see a stock market crash and you really need access to those funds quickly, you're going to want to move into a safer investment potentially so you don't risk losing the value that you've accumulated over those years.
OK, let’s talk about changing the beneficiaries. In my case, I have three kids. Let's say only two of them end up going to college. Well, I've been saving for all three in three separate accounts. But technically, if one of them decides not to go to college, let's say my oldest decides not to go to college, I could just transfer the balance of my oldest son's account and put it down to the middle and youngest son's accounts. And there's no tax repercussions, no penalties, nothing like that.
Or let's just say you have a smaller amount of kids, maybe just one or two children, and neither of them go to college, or they don't fully use the funds because they got outside scholarships or other financial aid. In that case, they wouldn't necessarily have a need for the higher education costs. Well, there's the possibility that you could transfer it to a different beneficiary. You could do it to a niece or a nephew.
Maybe you as a parent decide you want to go back to school, you could change it to yourself and use it to pay for your higher education. There's a lot of options and flexibility there. Whereas with those prepaid plans, you're doing it with absolute certainty that this particular person is going to this college and you're trying to lock in those rates. So pretty big differences within that 529 plan landscape.
Deb Meyer (14:33.45)
All right, the one other thing I want to touch on for 529 plans is around K through 12 expenses because I know there are several people listening to the podcast here that might want to send their kids to private school before they go to college. And obviously for a lot of people, private school is expensive. Depending upon which city you're in, there can be pretty substantial costs.
Again, it varies city to city, but I have a client in Boston and the private Catholic school tuition there is considerably higher than what I saw in St. Louis for comparable high school and grade school costs. And even here in Florida, we have a unique structure where a law was recently passed where there's some financial assistance for private school tuition up to $8,000 per student to send their kids to private school.
Florida is the only state doing something like that right now. But again, it's an option to make it more affordable. But let's just say you're trying to send your son or daughter to private Catholic high school in St. Louis. And I know from personal experience and working with clients there, co-ed school there is going to be about $12,000 to $13,000 a year. If you do a single-gender education, it's probably going to be closer to the $18 to $20,000 a year mark.
So for those kinds of expenses, obviously it's a huge cost, huge financial commitment, and certain states, in this case Missouri being one of them, would allow distributions up to $10,000 per year per beneficiary. So let's just say you chose to go to the co-ed high school and it's $13,000 a year. You only have cash flow to support half of those costs, and the other half you need to dip into the 529 plan. Technically you could do that and there won't be any penalty on the distribution. Now, every state is specific and just because you can do it doesn't mean you should do it. So the caveat there, if the beneficiary or the person who's going to benefit from it is younger that is receiving these funds,
Deb Meyer (16:56.158)
Just know that the account themselves, or the SOF 29 savings plan investments are typically age-based and they are geared more towards the age that they think they'll be reaching college. So it's gonna be a more aggressive investment mix early on. And then as they get older, it becomes a more conservative investment mix if that's what you chose when you set up the account. Now, if you're pulling money out at age 14, it's probably still gonna be a little bit more on the aggressive side compared to what it would be at age 17 or 18 when they're ready to go off to college.
You have to be mindful of that if you are pulling money out of that account just to kind of see what the investment mix is and hopefully try to replenish that account right away if you're taking money out of it, try to replenish it so that you still have that critical mass of savings for college and you're not just taking away the college savings option.
So again, just because you have the option of doing up to $10,000 per year per beneficiary, doesn't mean you should do it. If you have the cashflow to be able to make those tuition payments independently of the 529 plans, that's usually what most of my clients end up doing. It's gonna be very family-specific.
In the case of my husband, when he was growing up, his parents sacrificed to send him to Catholic high school, but they said, hey, you're going to be on your own for college expenses. So it really motivated him to make sure he could get scholarships and different types of aid to help pay for college. But in his case with high school, it was a huge financial commitment for his family and he's one of five.
Getting all of the kids through Catholic grade school and high school was a huge financial burden, but they did it and again, they used the resources they had available. But they just didn't have that financial availability for college. So it's going to be case by case specific on your family if you want to prioritize those private K through 12 expenses or focus more on the college expenses and how much you want to be able to provide for each.
Deb Meyer (19:21.474)
All right, let's do a quick break. I'm going to talk a little bit about my book, Redefining Family Wealth for a minute. One of the things that I'm passionate about, again, is educating. I work a lot with one-on-one clients, but I have a vast amount of experience and knowledge around family financial planning. And that book that I wrote in 2019, it really encompasses a lot of those lessons learned from the one-on-one planning relationships just into a more broad format that other people can benefit from if they're trying to get a nuts-to-bolts family financial plan and they don't want to go through a traditional advisory channel. It walks through the financial planning process and some of the steps to consider along the way.
One of the chapters is on college planning, knowing that cash isn't necessarily going to pay for college. But that's just one of many chapters. And I hope if you haven't already, just pick up a copy of the book, and hopefully you'll find it valuable. Okay, so we took a little break. Let's get back into how much to save, specifically for college.
There's no magic answer here. Every family is going to be unique. So depending upon what you, and if you're married, what your spouse had growing up, you could have vastly different ideas on how much you want to save for college for your children. In the case of some families, I see parents that have worked really hard, and they are very educated.
They have not only undergrad degrees, but master's degrees and they had no financial assistance from their parents. So for them, the goal might be to provide quite a bit of financial assistance for their own children because they saw how hard it was for them to take on all this debt. Other families say, you know what, I want my kids to work really hard. I don't want them being spoiled. I want them to figure it out on their own. So we're not gonna be providing a lot of financial support even if we have the availability to do so.
Deb Meyer (21:36.894)
I find that less and less often, but it still happens from time to time. For many families though, it's a happy medium. It's not one side or the other of, “hey, we're gonna fund it 100% or we're gonna fund nothing,” but trying to find a good meet in the middle spot. For a lot of families, they look at national in-state tuition, including room and board, is about $27,000 a year on average right now.
So if you multiply that by four years, that's over $100,000. And obviously if you go to a private school, you might end up paying more than that. If you're a non-resident of that state school, it’s more expensive. Let's say you're a Missouri resident and you're going to Alabama. My husband would hate me for saying that cause he's a huge Mizzou fan, but let's just say again, for sake of argument, you're going to Alabama for school as a Missouri resident.
You're going to be paying a heck of a lot more tuition than an Alabama student going to University of Alabama your freshman year. Those are all kinds of considerations to think about with what you want to be doing and really reflecting on your experience growing up, how much support you had, and then trying to figure out what a good game plan would be for your children.
Again, if you're married, take your spouse's background and thoughts into consideration and try to come up with a goal together. The other thing to think about too “is this student potentially going to go to grad school or pursue a PhD program?” If they have known since age five that they wanna be a doctor, obviously going and getting your MD is gonna be extremely expensive over time.
Undergrad is just one little drop in the bucket. So the amount of savings that you would need if you wanted to be financially supporting that student throughout their early adult years, is gonna be considerably higher than someone who's strictly going in a career that they're getting an undergraduate degree. The other thing to think about is school selection, and we're gonna go into more detail on this in the next episode where I...
Deb Meyer (23:55.71)
interviewed Joe Messenger. He really focuses a lot on college funding, especially for those that have children that are sophomores or juniors in high school and just how the financial aid process works and thinking through some of the implications of different schools and which ones can be more affordable. But I'll just touch on it a little bit today. One of the things to think about is
sticker price and what would actually be the final payment. If you have a student, let's say, someone who repeatedly gets A's and B's on their report card, they're doing well from a standardized test perspective, they have the potential, if they really wanted to, to consider going to Ivy League schools, if they're top of their class and have good extracurriculars and things like that, there's a possibility to get into an Ivy League school.
But again Ivy League schools have everyone who's applying and getting in who is at the top of their class and they're all very smart. So from an Ivy League perspective, they're not going to need to offer financial aid or I'm sorry I shouldn't say that they aren't going to need to offer merit-based aid (merit meaning grades, extracurriculars, grade point average, things like that).
If we focus on what is important for those Ivy League schools, they're looking at more need-based aid and they can offer need-based aid, but they can't necessarily offer merit-based aid. If your family doesn't have financial need, you're gonna be paying full sticker price for an Ivy League school.
But let's say your student isn't dead set on going to Ivy League and they want to consider a school that's still respected but is going to be a better long-term fit for them and they want to have potential scholarship dollars, they could apply to a different school that perhaps isn't as highly regarded as an Ivy League but still great education, great opportunity to form great relationships.
Deb Meyer (26:18.682)
I guess just being honest, this was me. I worked really hard in school throughout all of grade school and all of high school. And then, you know, did pretty well on standardized tests. And I was fortunate to be able to apply to several different universities. But ultimately, I got into Vanderbilt University, but I had no aid, none. And then I got into St. Louis University. I liked both campuses quite a bit. I thought …
“hey, these could both be good opportunities, but the financial cost of going to Vanderbilt was so much more than the financial cost of going to St. Louis University because I had a half-tuition scholarship.” They were specifically looking to attract students like me, so they were able to offer more scholarship dollars. Again, just because the sticker price might be higher, it depends on what specific type of school and what kind of availability they have for merit-based aid.
And then the other thing to think about is on the public universities, just because it's public doesn't mean it's going to be the cheapest option. So for example, with me and my sister, she went to University of Missouri - Columbia. We were living in Wisconsin. She was an out-of-state student for her first year. I think her tuition plus room and board was actually higher than mine at St. Louis University because I had that half-tuition scholarship.
She didn't have any scholarship as an out-of-state University of Missouri student. Again, it just depends on the specifics of what school, things like that. We're gonna go into more detail when I interview Joe Messinger later this month and release that episode.
Okay, so I also wanna hint on one thing before we move on from college savings. And this relates to 529 plan savings that you might've already had, especially if you have a special needs child and perhaps you didn't know they had special needs. ABLE accounts are another option to explore. I'm not an expert on it, but I do know they're out there and I just wanted to bring it up as another option to explore if you have a special needs child.
Deb Meyer (28:44.638)
And also talk about the fact that not everyone goes to college. Some students are really studious and they really have their heart set on going to college. Other students just struggle to make it through elementary school and high school, right? And there's no right or wrong there.
It's just every person's made uniquely. So understanding if your son or daughter is going to want to go to college can be challenging. Like if you see that they're the studious type and they have expressed interest in going to college, great. But if they haven't and they're really struggling in school...
year after year, it could be an indication that they're probably not cut out for higher education, that they'd be better off going to a trade school or perhaps becoming an entrepreneur. There are all kinds of different avenues they could pursue. For those that you're not sure if they're going to go to college or you just want to set aside some savings for them now but really have no clear idea if college is in the picture, a Roth IRA could be a good savings vehicle.
Obviously it helps you save for retirement, but it could also be used for college expenses. There is a special exception on the early withdrawal rules if you're using it for higher education. This is flexible in that you could be saving for retirement, but you could also be using that for college if they decide to attend college later.
UTMA or UGMA, which are essentially custodial accounts, those are other options if you're not quite sure if there's a college need. And those aren't great from a perspective of financial aid if your son or daughter does go to college because it is considered a student asset. So that's something to be mindful of if you're just on the fence. I would probably gravitate more towards a Roth IRA than the UTMA or UGMA as it comes to saving for them in the future and investing.
And then the other option, if you're just really not sure what they're going to want to do with those funds, and let's just say you just have one child, so the idea of passing it to a different beneficiary isn't an option, you could just set up an account in your name … a regular investment account, taxable brokerage account … and invest dollars there. And then as it grows over time, have a different named
Deb Meyer (31:10.286)
person that could manage the account if something were to happen to you. But just again, kind of earmarking it in your mind that it's for this person's benefit, for your child's benefit, that there wouldn't be any kind of formal designation on the account that it's intended for that person. Those are some alternatives to 529 plans if you're not quite sure if your son or daughter is college-bound.
Okay. Lastly, we're going to do a listener question. This comes from my friend Nick. He says, “we used to use Mint.com for a variety of things, including budgeting. I'm looking at Monarch Money to replace it once Mint is turned off in January. Have you ever used it? Do you recommend anything else?”
So this is a great question. Obviously, a lot of people are probably pretty upset right now if you've been using Mint and you see that, hey, they're shutting things down. Gotta make a transition here.
First off, I'm just going to say if you're using a budgeting tool, that's great. Honestly, it's so good to have awareness of where the funds are going. For some families, budgeting is not as big of a deal because they feel like they have a pretty good handle on cash flow. They know reasonably what they're spending on a month-to-month basis and they're able to save outside of that. But for other families, budgeting tools are essential and Mint has been a good tool over the years.
With it shutting down, some of the other ones that I would consider thinking about would be YNAB (You Need a Budget) or as Nick mentioned in his post, Monarch Money. I haven't personally looked at Monarch Money too much outside of just the general web page, but it does seem to have some other cool functionality in terms of monitoring your net worth and just being able to give some other insights if you're more the DIY type person and wanna not only have some budgeting tools but be able to monitor multiple accounts at the same time.
The other thing to think about, if you're not worried about budgeting for yourself so much but you're thinking about budgeting for teens, I did meet Bill Dwight, the CEO of FamZoo a few years ago and really like FamZoo, it's F-A-M-Z-O-O and it's essentially prepaid debit cards for the whole family.
It can be really good at teaching teens responsibility early on before they leave the nest. And there's just some nice ways that you can continue to monitor it as a family and know where each dollar is going. Those are some top-of-mind recommendations. But again, I'd encourage you to do your own research and look into each tool. Maybe do a free trial of if you're between YNAB and Monarch Money. Do a free trial on both and decide which one you like better. All right, I hope this was helpful. Have a wonderful rest of your day.