Think of the Children

WE PUT OUR TWO KIDS through college using 529 plans���and I estimate the accounts easily added 10% to the value of our college savings, compared to what we would have accumulated if we���d invested through a regular taxable account. Yet only 37% of families use 529s to help pay for college, according to a 2021 survey by Sallie Mae.

Like an IRA, a 529 plan gives you a tax break for saving for a specific goal���but, in this case, college rather than retirement. Money in a 529 grows tax-deferred and, if used to pay for qualifying education expenses, can be withdrawn tax-free.

You don���t get a federal tax deduction for funding a 529, like you can with a traditional IRA or 401(k). Several states, however, do give a state income-tax deduction, including Pennsylvania, where we live. Pennsylvania���s state income-tax rate is 3.07%.

Each year, Pennsylvania allows residents to deduct up to the gift-tax exclusion���$16,000 in 2022���for contributions to any 529 plan in the country. Other states provide a deduction for in-state plans only, which limits your choice. At the end of this article, I���ll offer some suggestions for finding a good plan.

We used Utah���s 529 plan because it had rock-bottom fees, offered low-cost index funds and didn���t charge a sales commission. We invested in lifecycle funds that started stock-heavy when the kids were young, then switched to a majority bond allocation as college neared.

When we took withdrawals, we owed no federal or state taxes because all the money was spent on qualifying education expenses. If you���re keeping score, this means 529 plans potentially offer a rare tax triple play: tax-deductible contributions at the state level, tax-deferred growth and tax-free withdrawals.

This tax trifecta is shared with only one other investment account that I know of���health savings accounts. HSAs are a bit more valuable, however, as they confer a federal income-tax deduction on contributions, rather than solely a state income-tax deduction, which is what we got for our 529 contributions.

Qualifying education expenses include the basics���tuition, room and board. They also include anything required by the school, such as books, equipment and fees. I imagine a personal computer is required equipment for today���s college students. A dorm room fridge or a puffy jacket, however, wouldn���t make the grade.

There was one more way that we saved thanks to 529 plans. For a decade, my wife and I carried credit cards that paid a cash reward to our kids��� 529 accounts. The Upromise card���s reward equaled 1.5% of each month���s credit card charges. We paid off the card���s balance in full each month and transferred the reward dollars to our kids��� 529s. Over a decade, the card���s reward payments added more than $3,000 to our family���s 529 account balances.

Even with our 529 savings, paying for college was a long, hard slog. We paid tuition for eight straight years. Our kids graduated without any debt. They now have good careers and lead happy, independent lives. To us, that���s the whole purpose of education.

If you���re saving for college, shop carefully for your 529 plan. Morningstar ranks the plans once a year, awarding them gold, silver and bronze medals. The Utah 529 plan we used still gets a gold medal, one of only three that Morningstar bestowed in 2021. Check to see if one of the prize-winning plans is offered in your state.

Meanwhile, you can research your state���s 529 tax breaks using SavingforCollege.com. We were lucky with Pennsylvania���s 529 rules. Many states are less generous. If your state���s plans don���t seem like a good fit and there���s no special state tax break for funding them, don���t force it. Instead, check out the plans from other states.

If you decide to open a 529 account, try to stick with a direct-sold plan. These are analogous to no-load mutual funds. The 529 plans sold by brokers tend to be more like load funds and charge higher costs.

Some people have told me they���ve held off saving in 529s in the belief it might hurt their child���s chance for a scholarship. Perhaps, but I don���t think this is a big risk. Money in a 529 account opened by a parent isn���t heavily weighted in the college aid formulas.

If your child does get a full ride to college, you can transfer money in a 529 account to another family member. You could even spend the money by going back to school yourself. New rules also make money in a 529 available to pay for K-12 education or to repay up to $10,000 in student loan debt.

If you don���t use your savings for eligible expenses like these, and instead make withdrawals for some other purpose, you���ll owe a 10% tax penalty and income taxes on the account���s investment gains, but not on your original contributions. If you���re worried about overdoing it, you might limit your 529 savings to perhaps half of what you expect your child���s college education to cost.

Of course, you may not need to save in a 529 if your child can run a four-minute mile or is a lock to be admitted to a national military academy. As for the rest of us, I suggest starting to save as early as possible. After all, as almost everybody will tell you, kids grow up fast.

Greg Spears is HumbleDollar's��deputy editor.��Earlier in his career, he worked as a reporter for the Knight Ridder Washington Bureau and Kiplinger���s Personal Finance magazine. After leaving journalism, Greg spent 23 years as a senior editor at Vanguard Group on the 401(k) side, where he implored people to save more for retirement. He currently teaches behavioral economics at St. Joseph���s University in Philadelphia as an adjunct professor. The subject helps shed light on why so many Americans save less than they might. Greg is also a Certified Financial Planner certificate holder. Check out his earlier articles.

The post Think of the Children appeared first on HumbleDollar.