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529: Investing for Kid's Education


Investing for their kids education is a priority for every parent I know. They all want to be able to provide their kids with great quality education. They want their kids to be able to go to college and/or higher education and they don't want their kids to graduate with huge piles of debt. In preparation many parents start investing for their children's education, usually through a 529 plan, although, from my reading it seems there are many other plans out there. In this blog post I will do my best to go through the main points of a 529 plan and at the end you can decide for yourself if it's the way to go for you.


The 529 Plan....

It was first issued by Congress in 1996 and was named after the section of the Internal Revenue code in which it is written in, section 529 "Qualified Tuition Program." It was designed to make it easier on parents to prepare saving for their kid's education. You can think of a 529 plan much like an IRA. It's an account created to fulfill a specific purpose, in this case funding education. There are two basic 529 plans: A prepaid tuition plan and a savings plan.


Prepaid Tuition Plan...

This plan allows contributors to invest in a state-run fund that will cover the costs of future tuition. It takes into account tuition inflation. Unlike a 529 savings plan, a prepaid plan allows you to buy your semesters ahead of time that will then get redeemed at a future date. The money gets pooled together amongst you and the other contributors and then is managed by an account administrator who then invests the money for the long-term. When your child is ready to go to college, the funds are then transferred over to cover the cost of tuition. The catch here is, is that your child must attend a state college. If your child attends an out of state college, you may get some kind of credit, or get a refund of your contributions. Also, with a prepaid plan, only tuition is covered, NOT room and board. That, it seems, you'll have to figure out on your own. Prepaid plans are not guaranteed by the federal government, so your funds are only safe as long as your state doesn't experience a financial shortfall.


Education Savings Plans...

This plan allows the investor to open up their own education savings account either through a financial advisor or broker. Of course, right away, you guessed it, there will be fees that you have to pay these individuals, but you get more "freedom." An Education Savings Plan can be used at any university nationwide and even some schools outside the country. With these accounts the investor may invest in a broader range of financial instruments i.e. Mutual funds (Ew), ETF's, and Index Funds (Yay!!). Investors may also choose a target-date fund which will automatically change the portfolio accordingly as the beneficiary gets closer to attending college. It will start out more aggressively and then become more conservative as we get closer to college time. The money in this fund may also be used to help fund up to $10k of elementary or secondary school expenses if need be. All Education Savings Plans are state sponsored, but in no way are you obligated to invest in your state's plan.


Fees...

With any 529 plan there are always fees to consider. The 529 account itself will have a fee along with the fees of the underlying assets. A pre-paid plan will have an enrollment/application fee as well as an ongoing administrative fee. I'm not sure exactly how much, but it will be less than an Education Savings Plan. With an Education Savings Plan, there will be an application fee, annual account maintenance fees, ongoing management fees. And if you buy your plan through a broker expect load in fees on the front and back end. Sounds like mutual fund to me.


Taxes...

A 529 Plan can offer investors with special tax benefits both federal and state level, but they vary of course depending on the state that you reside in. Some states allow you deduct your contributions from your state income level. However, it is important to note that the funds in the 529 plan can only be used for qualified educational purposes. If your child decides to not go to school, you can not liquidate that 529 account without paying a 10% Federal Tax Penalty and Federal and State income taxes. You may roll over the plan to another beneficiary (second or third child) at no cost.


My 2 Cents...

If you'll allow me I'd like to end by giving my two cents on 529 education plans and this is only as so far as my reading goes. I have no experience yet with 529 educational plans other than being the beneficiary of one. Also, as I have said time and time again I am NOT a financial advisor. With that being said, it seems like the lack of liquidity, the fees, and the rules make the 529 plan a poor investment choice for those of us who are more financially literate. Why go through the hassle of opening a specific account for your kids that HAS to be used to fund their education. Now I'm not saying by any means that we shouldn't fund their education, but why is an education account the only way to do it? It's not! Just open a regular brokerage account for them invest in some index funds or other assets and call it a day. If they don't go to college then fine, you can spend that money on other things. You don't have to pay a Federal Tax Penalty.


The only benefit I can see is the tax benefits, but I'm not convinced that it's worth the excess fees, the decreased liquidity, and the overall lack of freedom you have over your money. These "special" accounts seem more and more like false security to me. You have to pay extra to have these accounts and there are so many rules that you have to follow. Why not just keep it simple: Brokerage accounts and a good array of simple index funds--Total Stock Market, Total Bond Market, and Total International for example. Done. Just have the discipline to keep it for your kids education and have other brokerage accounts for your retirement and your investments. I'm a big believer in having flexibility and the room to adapt. In order to do that you need to have full power over your money. To wield that power wisely, however, you have to be more financially literate.

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