July 23, 2024
The way to save (and invest) for those skyrocketing educational expenses.
Hello, everyone! Welcome back. You're watching another episode of Money Fundies. My name's Matt Stearns, and you're here at Millennial Money Management. If you missed our last episode, we talked about individual retirement accounts—what exactly a Roth IRA is and how it differentiates itself from the traditional IRA. So, please check that out if you missed it.
Today, we're going to be talking about 529 college savings plans and just how useful of a tool they can be to save for a child's future educational expenses. Okay, so a 529 savings plan is a state-sponsored educational investment savings plan where you make contributions to this plan, and you can invest the money with the limited number of options that they give you. Of course, from a fundamental standpoint, the theory behind this is that investing that money over 18 years, for example, is better than just putting away money in a checking account. Okay, and I'll give you an example later on of just what those numbers look like.
So, what you do is you typically make after-tax contributions. You take whatever's in your bank account or leftover from your paycheck after all the taxes have come out, and you make a contribution to an account that you set up in your child's name as the beneficiary. So, if you're a parent and you set up an account for your child, you are the owner of the account until the child turns 18, and until then, he is named the beneficiary.
Another important thing to note here is not only are you allowed to contribute on behalf of your child's account, but anyone is able to contribute. Anybody, including your family members, can also, in the state of Pennsylvania, get a tax deduction for whatever they contribute, up to the maximum, which is $15,000 per year. Okay, so pretty, pretty nice little perk there! Not only do you get after-tax growth—which I'm going to get to in a minute—but you also get a tax deduction on everything that you contribute. So, a little bit of a double whammy as far as tax benefits go, and that's one reason that these plans are so nice.
So, after we make contributions, if we use the money for a qualified educational expense, we get all of the growth that we earn on our investment return completely tax-free. So, whatever balance we have when this is all said and done to withdraw to pay for expenses—that's all tax-free. Okay, so we might contribute, you know, over the next 18 years—let's call it $45,000—but if our balance is $90,000 because we've invested it, then we get that extra $45,000 completely tax-free. So, that's a huge perk behind it, and that tax savings that I mentioned before, the tax deduction in the state of PA, is pretty slick.
Any qualified educational expense just got extended, actually, to include private schooling, K through 12. So, if you have a child that you want to send to a private institution in elementary school or high school, you can use the 529 to pay for that. You can also use it, of course, for college expenses like tuition, room and board, fees, and books.
Now, another nice thing that people don't often realize is that, well, what happens if I save for my child's education and something happens that he decides not to go to college? What can I do with this money? Well, if you don't use it for qualified education expenses, there is a penalty, and you will have to pay taxes on your growth. However, you can also roll over these funds to another family member. So, you can roll over this account to another child that perhaps may be going to college, to a niece or nephew. Really, it's a very flexible way to move this money around, and of course, we're still better off paying taxes and the 10% penalty than not having invested it at all. So, it's still a very wise way to go about saving for your child's future educational expenses, which we know are becoming exorbitant right now.
So, it's my recommended way—it's really the financial industry's most strategic way to go about investing to utilize some growth in time to expand the amount of money that you can save for your child's education. Okay, instead of saving up, for example, $2,500 every year for eighteen years—that's $45,000. If you invest it at a 7% return (which is not guaranteed, however reasonable), you would double the amount of money you save. It's almost $90,000 you'd have in there! So, that's one of the real benefits of utilizing a 529 plan. Also, we have the tax-free growth benefit, and we have the tax deduction in PA.
So, if you are a new parent and you're thinking about ways of how to go about saving for college, talk to a professional about these 529 plans. Ultimately, somebody is going to have to build the portfolio and/or make a selection about the investments to use, and you can do that yourself if you're comfortable, or, of course, an advisor can facilitate it. But 529s are definitely the way to go in the college savings realm.
Please reach out to me if you have any questions. I have a lot of people asking me about this topic, in addition to all of my Millennials with their large student loans who are trying to refinance. So, it's a great way to really get ahead and save up for your child's future with a couple of nice tax benefits.
So, that's all I have for you today. Please like, subscribe, and comment below, and of course, we'll see you next time. Thank you very much!
