Key Takeaways
You are not required to use your own state’s 529 plan. Look carefully at fees, expenses, investment options, and performance.
It’s never too late to start saving for a child’s (or grandchild’s) higher education, but the sooner you start, the more time your money has to compound.
A 529 plan is similar to a retirement plan when it comes to asset allocation and glide path before withdrawals start.
As the cost of higher education continues to outpace inflation and wage increases, more and more Americans are scratching their heads wondering how they’ll pay for it all. As with saving for retirement, the sooner you start saving for your child’s education the better. That way, the power of compounding can work its magic. Don’t make the mistake of waiting to see if your child (or grandchild) is “college material” before setting up a college fund – and don’t expect an athletic scholarship to bail you out. Only a small percentage of high school athletes receive college athletic scholarships -- and most don’t come close to covering the full cost of tuition, room, and board. Also, with your above-average income and home equity, you likely earn too much to qualify for most types of financial aid.
That’s where 529 college savings plans come in. Many of you understand the basics. If you need a refresher, see my past posts about this topic.
You’re not beholden to your home state’s 529 plan Many well-intentioned parents (and grandparents) don’t realize they can utilize out-of-state 529 plans to take advantage of lower fees, better investment options, performance, and customer service. Even better, there are no fees, penalties, or restrictions for building your college-saving nest egg out of state.
The State of New Jersey’s plan, for instance, is not usually ranked among the top performers and it charges higher fees with fewer investment options than many other state plans. Some may have seen that New Jersey now allows residents to take up to $10,000 a year in state income tax deductions if they utilize their home state’s plan. Not only is there an income cap of $199,000 for this deduction, but in terms of real numbers, the modest tax savings is probably not enough for years and years of higher fees, sub-par performance, and limited investment options. That’s why we recommend the State of Utah’s 529 plan for many of our clients. We have found their investment selection to be more than adequate, their fees to be among the lowest in the nation, and their user-friendliness among the best. As a free service for our clients, we analyze the best 529 plan options from an investment, fee standpoint, and tax perspective. We can also help you set up a 529 plan, transfer to a new one, review your asset allocation and glide path regularly, and can make contributions on your behalf. We don’t charge a management fee for assisting clients with their 529 plans, since funding for education is a very high priority for our firm.
Avoiding common 529 pitfalls
1. Not starting early enough. We’ve had successful clients come to us with seven to eight-year-old children and tell us they’re ready to start saving for college. They tell us college savings
has always been on the back of their minds, but there was never a sense of urgency before. Even with kids only 10 years away from college, it’s not too late for the couple to start saving. However, they’ll have to make larger regular contributions than parents who start saving when their kids are infants. That’s because they’re on a much shorter runway before tuition withdrawals must start and they won’t have as much time for their account to grow. It’s just a matter of setting expectations and maybe looking for ways to cut back spending in other areas of their life, depending on how high of a priority they wish to put on funding education.
2. Believing you can’t start a 529 plan before the kids are born. Not true. You can set up a plan at any time for unborn children or grandchildren. Switching beneficiaries is simple and is a strategy utilized for generational education planning.
3. Using 529s for K-12. 529 plan rules now allow for up to $10,000 per year to be applied toward private elementary or secondary school tuition expenses. Just make sure your state complies with the recent rule change. If it doesn’t, you could be facing a 10% penalty for “non-qualified” withdrawals. Also remember that money you withdraw today to pay for pricey K-12 private school tuition is money that can’t be growing and compounding for your child’s college or graduate school. Again, you may have to reset expectations or take out loans for their higher education pursuits.
4. Being too conservative or too aggressive in your asset allocation. Being too conservative when your kids are young doesn’t allow for the money to grow and compound enough to keep up with inflation, much less the ever-rising cost of tuition. The time to be aggressive is when your children are young and the account has time to withstand multiple market cycles. On the contrary, being too aggressive, like 90% in stocks and 10% in bonds when kids are finishing up high school, doesn’t allow enough time for the account to recover if markets plunge 20% or 30% right before they head off to college. Just like with your retirement accounts, how you allocate your 529 plan is a crucial consideration for successfully achieving your goal of education funding.
5. Trying to time the market. No matter which goal you are saving for, research shows it is almost impossible to time the market consistently. That’s why it’s important to figure out the best funding method given your situation, whether it be a lump-sum or periodic contributions. For the latter, do not let the market drive your decisions. Stick to your contribution schedule. We work with our clients to understand the constraints of their time horizon, so you can be confident that, along with adjustments to the allocation as college approaches, you can successfully fund this goal.
Real-world example
One of our new clients was a Pennsylvania resident with an infant daughter. He had already opened a 529 in the Pennsylvania state plan, but we advised him to switch to the Utah (my529) plan, so he could lower his expected expenses for fund fees and overall management fees. We know the Pennsylvania plan well. Although it offers in-state residents some tax benefit for using their plan, we have found that over the long term, the benefits of using the Utah plan’s investment options, and making consistent monthly contributions with our account oversight, would allow our client to sock away more than enough money to fund his daughter’s entire undergraduate education. Conclusion
Again, helping clients reach their higher education goals is a very high priority for our firm. We can explain the basics, create paperwork to open or move accounts, set up contributions, monitor accounts, and integrate 529 into your holistic financial plan, all at no additional cost to you. If you or someone close to you has concerns about college savings for your children or grandchildren, please don’t hesitate to reach out. We’re happy to help.
BRENDEN LEESE, CFP® is an Associate Wealth Advisor at Novi Wealth Partners