One of the most intimidating aspects of raising children is the associated costs. It’s a tremendous financial commitment. If you plan to pay for your kids’ college expenses or at least help, a 529 Plan can help relieve a significant portion of the financial burden. The earlier in a child’s life that you can get money invested into a 529 Plan, the more it can help!
So What Is It?
The biggest benefit to a 529 plan is that the account can grow tax-free, with no annual income taxes on money invested in the account and no capital gains taxes at withdrawal as long as the money is taken out to pay for college. This can represent thousands and thousands of dollars in savings over the years.
There are two types of 529 Plans: the College Savings Plan and the Prepaid Tuition Plan. The college savings plan works a lot like a retirement investment account would, with most institutions allowing you to select a risk level and use one of their managed investment strategies or giving you the ability to choose how your funds are allocated. As with any investment of this type, the account value can go up or down based on the market conditions, and there is certainly risk involved. The prepaid tuition plan allows you to pre-pay for in-state public colleges.
For the parent of a young child, trying to make sure they are prepared for whatever may happen in the future, the college savings plan is typically the right choice. You can deposit a lump sum once, set your investment strategy, and let the power of compound interest work its magic over the years, or you can set up regular contributions of any set amount over any set period of time. To take advantage of the tax savings when it is time to withdraw the money, you’ll need to use it for college-related expenses, including tuition and fees, textbooks, computers, and required supplies, and in some cases, room and room board as well. These distributions can be used in a limited fashion for some K-12 schools before college and can also be used to repay student loans.
What If We Don’t Use It For College?
There are a lot of scenarios in which you may not need to use this money for college. Education expenses are a hot-button political topic every election cycle, with total outstanding student loan debt being over $1.5 trillion as of 2020. Many states are offering free community college programs to get a 2-year degree, and many ideas are being floated out there to make college more affordable. Even if college remains as expensive as it is today or gets more expensive, there’s always a chance that your brilliant, amazing child earns scholarships. College also isn’t for everyone, so maybe they don’t even go!
Fear not! The money invested in a 529 Plan can be withdrawn at any time, for any reason! If you do withdraw the money for anything other than qualified expenses, you’ll pay income tax and typically there will also be a penalty for the earnings portion of the account. That penalty can be waived under certain circumstances, but the income taxes will still be owed. Even if you have to pay a penalty, though, if your child has earned a free ride to school or has found a fulfilling path that doesn’t involve college, having money available to help with other things (down payment on a car/house, pay for a wedding, jump start a retirement account, etc.) is such a blessing!
You can also avoid those penalties altogether if you change the beneficiary of the account to another family member, including, but not limited to, siblings, cousins (1st), nieces or nephews, parents, and more! Imagine being in a position to be prepared to pay for your children’s college expenses, not needing to, and being able to bless a family member in such an amazing way. These are the kinds of gestures that can change entire family trees for generations, for the better.
With our daughter, we created an account and made a one-time investment when she was around 9 months old. When looking around for where to do this, we did a lot of research and ended up creating an account with Wealthfront. They will manage our first $10,000 with no fees, and had a really easy setup process with great reviews. They also have a nice, intuitive app and web interface.
We chose a relatively aggressive investment strategy since we had ~17 years for the money to grow before it was needed. We can handle market swings and want to maximize our return. Our daughter is five years old now, and our initial investment has more than tripled in less than 5 years. Each year, as we analyze our financial situation and plan for the future, we look at whether or not we think we need to continue contributing to the account. Currently, we feel that it is on track to meet our expected needs. Still, if that changes, we may consider making another lump sum deposit or schedule regular monthly deposits to help supplement the account.
We have been very pleased with the results in the Wealthfront account, but when our son was born, we decided to create his 529 account with Fidelity. I have an individual investment account through Fidelity, and frankly, I wanted to compare the differences in performance between Fidelity’s managed options and Wealthfront’s. We made a similarly sized one-time investment in our son’s account as we did for our daughter, although he was closer to 6 months old at the time than 9 months old.
It’s far too early to tell if there’s a dramatic difference in performance, and market factors will certainly apply. Still, I will say that Wealthfront’s app and website are both significantly more intuitive and attractive. We will continue to monitor performance and adjust as needed.
The Bottom Line
Time in the market beats timing the market every time. The best time to start planning for your and your family’s financial future is early on, when everyone is still young and has plenty of time for their money to grow. The next best time, if that moment has passed, is today. Many 529 plans can be started with as little as $25!
For more information, check out these resources from the SEC!
What other things are you doing to ensure that your children are set up for a healthy financial future? Please post in the comments below or join us in Discord to discuss!