Alternatives to the 529 Savings Plans
There’s no doubt that a 529 savings plan is one of the best available options for college funding. It has a high contribution limit ($14k annual eligible for gift splitting up to $28k annual and it can even be super funded in the initial year up to $140k). The owner of the 529 savings plan can direct the investments (within plan constraints), and is even allowed to change the beneficiaries. Depending on state of residence, contributors may be eligible for a state tax deduction based on 529 contributions.
Here are a few instances where it may be beneficial to review an alternative or a supplement to the 529 savings plan before deciding which direction to take:
My child knows where they want to go, and/or I don’t want to be subject to investment volatility.
The 529 pre-paid tuition plan is a great fit. Just know, the pre-paid tuition program is only available in a limited number of states. However, there are several benefits if it is available. The major benefit is to effectively lock-in today’s tuition costs for an education in the future. This is beneficial because tuition for four-year public schools has risen an average of 3.5% above inflation over the last 10 years1. Second, the investment risk is shifted to the sponsoring state. The value of a pre-paid tuition plan will not decrease in a market sell-off and can guarantee that your child’s tuition will be paid for.
There are disadvantages besides limited availability. Since it effectively purchases in-state tuition from a specific state, it may not provide the same value in private universities or out-of-state institutions. There will likely be a transfer value, but it may not fully cover the costs of outside institutions. The 529 pre-paid tuition will only cover tuition and fees associated with attending college. Books, room and board, and other necessary expenses will have to be paid through other means. If your child may be eligible for financial aid, a pre-paid tuition plan will most likely disqualify all needs-based grants and loans.
I want to use the funds for non-qualified 529 expenses and want to manage my own investments.
A Coverdell Education Savings Account has more flexibility in investments (similar to an IRA) and eligible expenses. For example, a Coverdell can be applied to secondary education expenses as well as post-secondary, such as uniforms, computers, and transportation. This can provide tax savings while covering education expenses before college. Note that a Coverdell annual contribution is limited to $2,000 per beneficiary (no gift splitting or multiple contributors allowed). Eligibility to contribute to a Coverdell is based on Modified Adjusted Gross Income (MAGI) and the phase-out ranges for $190k-$220k (Married Filing Joint taxpayers, phase-out is half that for single filers). The beneficiary can contribute $2,000 to their own Coverdell, so the phase-out is workable. While a child’s entire education will most likely not be funded with $2,000 year, contributions can be maxed to both a 529 savings plan and a Coverdell in the same year.
A Roth IRA is also an education savings option. It should not be considered a true education savings vehicle, but it can be considered a source of withdrawal if needed. This would only be a good choice if your child may not attend any higher education institution, at that point the funds will be sitting in a retirement account and can be withdrawn tax-free after age 59 ½. If you do chose to use some of the funds for qualified education, contributions can be withdrawn tax-free and penalty free at all times. Earnings taken out before five years and before age 59 1/2 would normally be taxed and penalized at 10% early withdraw. However, since the funds are being used for qualified education expenses, the penalty will be waived. Earnings withdrawals before five years since account opening will still be taxed as income. A Roth IRA contribution is also subject to income phase-out, and there is no federal or state tax deduction. There are risks to your own retirement lifestyle by withdrawing from a Roth IRA to fund education, so consider this option with a grain of salt.
Much like retirement, there are many ways to fund education goals. We often get stuck in a pinhole view and see the 529 savings plan as the only option. There are several alternatives / supplements that can add additional value to education savings and it is important to consider the whole situation. Please contact your Relationship Manager if you would like to further discuss possible education funding options.
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