If you’re a parent, grandparent, or even a doting aunt or uncle, you may want to pay for a child’s college tuition. We all want the best for the little ones in our lives so why not start early with a 529 plan to pay for college? Many families put off funding for college until the child is in high school and that makes paying for education much more challenging. Instead, you should start early; like at birth. Little deposits invested over time can grow to substantial balances!
Investing a few hundred dollars a year for 18 years is a lot easier than waiting until your child is in high school to figure out how to pay for higher education. For example, if you start at birth with a $1,000 opening balance, contribute $100 per month for 18 years, and earn a conservative 5% return, you could accumulate around $36,165. Of course, a higher return, or periodically adding money from friends and family over the years will greatly add to the amount. If you get the grandparents on-board for another $100 per month, you could accumulate around $70,000. This is just one simple example.
How you save and invest that money also matters. Remember our hypothetical 5% return from the above scenario? Well, depending upon your risk tolerance, that return could be lower, or possibly higher. It all depends on how conservative, or how aggressive you want to be. So, with either risk tolerance, what investments within the 529 plan do you use to get to your goal?
Most 529 plan offerings today have several investment options for you to consider. You can likely select a cash option, an age based option, a static option, or an individual option. Let’s look at each in more detail.
For cash, it is exactly what it sounds like – cash. Your money is likely earning little or nothing for a return. If you’re lucky, the 529 may have a CD offering or a money market offering to park your cash. This is most likely going to be your slowest, lowest earning option. Translation; you’ll need to save a lot of cash to reach your goal.
Age based options are very similar to target-date retirement funds. Sometimes, they are referred to in 529 investments as ‘enrollment-based’ options. These funds start out more aggressively allocated to equities when the child is younger, and gradually become less aggressively allocated to equities and more allocated to fixed-income (bonds, cash) as the child ages. The idea being that as your child enters high school, the account is somewhat protected from market downturns.
Static options refer to investment selections that don’t change over time. That is, you select a portfolio with a fixed percentage of equity, bonds, and maybe even cash. It depends on what’s offered by your 529 provider. For example, you might select a passively managed, diversified growth option that is 70% equity and 30% fixed income. Remember, unlike the age based allocation, this static allocation remains the same over the life of the investment. If little Johnny is a junior in high school and there’s a broad market downturn, this portfolio option could very well feel the impact more so than the age based selection.
Individual options generally refer to a single fund option. These single fund selections are for the most part, mutual funds. The fund may be a mix of equity and fixed income, or it could be a specialty fund that is all equity.
What’s offered for investment selection and the combinations of equity vs. fixed income can vary greatly among 529 plan providers. You may, for example, not like the age based option becoming more conservative each year, and instead want a static portfolio but are unsure of when to make changes to decrease equity exposure. You can work with your financial planner to make these decisions.
Furthermore, if you recall, the 2017 Tax Cuts and Jobs Act ushered in sweeping changes to 529 plan accounts. Prior to the 2017 TCJA, you could only use 529 plan funds for paying qualified expenses for higher education (think university). Remember, the idea was that you saved from birth and your contributions grew tax free to pay in a tax-advantaged way for your child’s education. Some states even offer various state tax credits for contributions to 529 Plans. So, what’s changed?
529 plan owners can pay for K-through-12 private school tuition! Up to $10,000 per child, per year for each account. This was a big change. But should you use 529 funds to pay for K-through-12 education? For starters, it is not the best use of plan funds for those struggling to save for college. If your child is in private school and you dip into recently contributed funds for current tuition, the funds have not had time to grow. However, if a 529 plan owner is wealthier, and the state in which you live offers a state tax credit (California does not), you can fund the 529 plan, get the state tax credit, and pay for private school tuition.
Each 529 plan owner’s individual situation will determine how they will use the 529 account to pay for education. Overall, if you have the financial ability and live in a state with a tax credit, this could be beneficial. If you have not reached a savings level to cover college expenses, and you dip into funds early for K-through-12 tuition, this could greatly reduce your available funds to pay for college.
Working with a Certified Financial Planner™ you can target specific school options and calculate the future anticipated tuition of a specific private school or state school and craft a plan to meet your funding goal be it for current tuition or for university. As parents, you have the choice of funding a percentage of the education bill or asking your child to work and pay for part of their own education. Factoring in grants, scholarships, awards, and loans is also part of the equation. The key is to get help as early as possible, have a plan, and let time (and compounding) work to your advantage. One thing you do not want to do, is fund education without funding your own retirement first. Retirement should take precedence. Remember, your child can borrow for school if needed; you can’t borrow to fund your retirement.
Let’s do this! As an independent Certified Financial Planner™, I can help you plan your child’s education tailored to your goal, timeline and resources. Contact me and let’s get started! #talktometuesday #education #CFPPro #CFP #Hireaplanner #529 #529plan #college #collegedream #school #studentloan