Flow Chart for a 529

The 529 is a valid option for saving for college. You place money for future college expenses in a special account called a 529.

These accounts were named after Section 529 of the IRS code that originally created them back in 1996 in response to the need to save for ever rising college costs.  The concept is simple.  You set money aside in a special savings account administered by a state or educational institution.  There are no federal tax savings when money is first placed in the account, although many states will allow a deduction off the state income tax.  However, there will be no tax on any future capital gains, interest or dividends if funds are later withdrawn for qualified educational expenses.  Depending on your tax bracket, you could save a full one third of this future growth that would otherwise be forfeited to federal taxes.

Let me repeat, the 529 is a valid option for saving for college for some individuals.

Let’s do a simple flow chart and see if they are for you.

First, are you contributing enough to your 401K at a work to receive the maximum amount that your employer will match?  If your employer matches the first 5%, then you should have 5% allocated to your 401K.  If he matches the next 3% at only half as much, then you should still allocate an additional 3% for a  full 8% to your 401K.  You have just doubled the first 5% of your savings.  The next 3% received a fifty percent boost.  No other investment offers such immediate guaranteed returns.

If you are maximizing your 401K, read on.  If not, then the 529 is not for you.

Second, are you fully contributing to your IRA?  Currently (2016) you can contribute $5,500 to an IRA – either Traditional IRA, Roth IRA or a combination of both. (i.e., $3,000 to a Traditional IRA and $2,500 to a Roth IRA for a combined total of $5,500.)  Individuals over 50 can contribute an additional $1,000 as a catch-up contribution.  IRA’s can be funded for both the husband and wife provided at least one spouse has taxable earned income of at least the current year’s IRA contributions.  IRA’s can be opened at any bank or brokerage house.  You should check with your tax advisor before opening your IRA and then you should fund your IRA every year.

So, if both you and your spouse are fully funding your IRA, read on.  If not, then the 529 is not for you.

Do you expect to apply for and receive financial aid in the form of federal grants and loans?  When my husband and I filled out our first FAFSA form for our eldest son, we were amazed how much we were expected to contribute to his education. We were further dismayed to learn that the 529 we had diligently saved counted directly against us when it came to determining how much federal financial aid he would receive.

If you do not expect to receive any financial aid, the 529 my be for you.  If you expect/hope to receive federal aid, then the 529 is not for you.

Will you be eligible for education credits such as the American Opportunity Credit, Hope Credit or Lifetime Learning Credit? One of my favorite moments when completing taxes is asking parents for their students 1098T college tuition statements.  If their income is under $80,000 ($160,000 if filing joint), they are eligible for the American Opportunity Credit (AOC).  The AOC can reduce the tax bite by a full $2,500 for each of four years, a total savings of $10,000 over your child’s college career, based on qualifying education expenses of at least $4,000 each year. The Lifetime Learning Credit can reduce their taxes by a further $2,000 as long are attending school.   The government, however, does not allow double dipping.  If you pay college expenses with 529 accounts, you can not use those same college expenses to qualify for the AOC or other education tax credits.

If you will qualify for education credits based on your expected income, do not invest in a 529.  If you are lucky enough to be highly compensated and will thus not qualify, then read on.

Do you have superfluous funds that you are willing to allocate solely to education?  When you start a 529, that money is earmarked for education.  If you use it for anything else, you will pay penalties and taxes on the growth.  Of course, if your child does not attend college, you can share the 529 with another family member, or even use it yourself to further your own education.  I, for one, would prefer not to limit my investment dollars.

As I stated earlier, the 529 can be a fine way to save for college.  But without a crystal ball, I am reluctant to place limited resources in such a limiting account.  The ROTH IRA will overcome virtually all the concerns about saving for college, and will leave you maximum control over your investment dollars in the future.

 

 

 

 

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