I have to just come out and say it….Do Not Open a 529 college fund for your kid!
A quick “google” of 529’s will give you a plethora of sites singing the praises of the 529 college fund. The concept is really simple. Start saving early. Your money will grow tax free. When you take it out to pay higher education expenses, none of the money will be taxed. Your child will walk debt-free across the stage at commencement.
Unfortunately, life is just not that simple. And unless you have a crystal ball, the 529 is not necessarily a good thing.
Suppose your child is incredibly talented and leaps right from high school to a music or acting career. Or perhaps they are athletic and head right into the big league. No college for them. You cannot touch the money you had saved in a 529 without incurring penalties and taxes. Imagine how disheartening it would be if your child decided to live in your basement and play video games. You would be even more discouraged about that 529.
Our friend’s son went right from high school into the marines. They certainly were proud of him. They had also dutifully saved for his college education in a 529 account. They can’t touch that money without triggering penalties and taxes unless they use it for education. Their only child is making a career of the military and does not expect to need it for his education. The only option is to give the 529 money to a distant relative or bite the bullet and pay the taxes and penalty. Neither choice is very appealing.
But suppose you have a student who is following the traditional path of high school to college to career. Aren’t you glad you started that 529 for them now! Not so fast. Nearly all students will fill out the Fafsa, and your child’s financial aid will be negatively impacted by your prudent college savings.
The Fafsa is the Free application for federal student aid form. By submitting the Fafsa form you will be told your “expected family contribution” or EFC to pay for college. This will determine the federal grants and loans that your student is eligible for. The Fafsa form is incredibly detailed, requesting information from the parents’ and the child’s tax forms, their savings, investments, wages, property, partnerships, 529 savings etc. Parents are currently expected to contribute 5.64% of their assets towards the EFC; students contribute 20%. The bite is harder on earning; Fafsa uses 22 – 47% of the parents’ earnings and 50% of the student’s income to calculate the EFC. Put another way, nearly everything you have saved and everything you earn can be used to reduce your student’s federal grants and loans. (There are a few exceptions such as retirement accounts and the family home. You’ll find out how to use these to your advantage in this blog entry. – MoneyMommy)
Okay, despite everything I said, you still want to save in a 529 account. You’ve heard this is the best option, and I haven’t managed to convince you otherwise. While I commend your due diligence, let’s see what happens to your taxes now that your child is in college. There are awesome education credits that can reduce your taxes by $2,500 for up to four years. That is a savings of $10,000! After four years, there is unlimited tax savings of $2,000 per year through the Lifetime Learning Credit. Wonderful! Except for one small problem. You used a 529 account to pay his college expenses. The government does not allow double dipping when completing your taxes. You will not receive these education credits for any expenses that were paid for with 529 funds. Your diligence just cost you $10,000 in higher taxes.
So, unless you are quite well off and are maxing out all of your retirement accounts, have lots of spare change, don’t expect to receive any financial aid, and won’t qualify for any education credits, do not start a 529 account!