Nutritious and balanced dinner? What do you mean kids can’t eat pizza and beer every night? You’re now asleep WAY before the late night talk shows hit the airwaves. Unless, you live in the central time zone. Everything there comes on early. On the plus side, you’re probably much more informed due to watching the early morning news, now that you’re getting up hours before you used to.
But it’s not only lifestyle changes that hit you fast, it’s also financial changes that quickly become apparent. Feeding multiple mouths, buying clothing, toys, and necessities for kids, not to mention childcare. Your money flies out the door faster than the cool air out the refrigerator when your toddler leaves the door open.
That’s why for us, planning for the future has become a top priority. Making smart financial decisions now, makes it SO much more enjoyable down the road. That’s especially true when it comes to college.
I’m sure you’ve seen what it costs to go to college these days. I’ve got a defibrillator on standby just in case. So that’s why starting to plan now can make a world of difference.
You’ve probably heard of 529 college savings plans before, but you might not know all the specifics on why they can be so beneficial for parents and kids. So, what is a 529 college savings plan? As tax free earnings, a 529 plan could be a fantastic way to help save money for college and ease the financial pain when the day arrives.
We just opened ours and had lots of questions and figured you did too. So we chatted with Michael Parker, Executive Director of the Oregon College Savings Plan. He shared with us why everyone - no matter where you live - should consider a 529 college savings plan and breaks down the serious benefits of starting one now.
Did you know you can pass them down through generations? Yeah, me either. Here’s our interview with Michael. It’s chalk full of great tips you need to know to start planning for college.
When should parents start investing in a college savings plan?
Ideally parents should start as soon as their first child is born. The longer you have to save the more you’re going to have, similar to retirement. On the other end, it’s also never too late to start saving. I work with a lot of parents who either didn’t know college savings plans existed or didn’t know about them and their children are 10, 11, 12 years old. That’s still a pretty good time horizon. If you think of a kid that’s 12, that’s six years until college and four to five years while their in school, so that’s still a pretty decent time horizon. Obviously, the earlier the better but the mantra is it’s never too late to start saving.
What percentage should I consider putting away each month?
I get this question a lot from parents, ‘how much should I save?’ At the end of the day it’s really dependent on your personal situation. We really don’t look at it as a percentage, we really try and say ‘what is your goal?’
For example, is your goal ‘to send my kid to an in-state university for four years?’ Since I live in Oregon, lets look at the University of Oregon. To send my kid to the UofO for four years, it’s going to cost me roughy $80,000 - $85,000 total, for the all-in cost for four years. So if my goal is, ‘ok, I want to be able to pay for half of that,’ then I can look backwards and say, ‘how much do I need to pay per month to get $40,000 put in here by the time my kid is 18?’ So we really try to tell parents, get a goal, have a goal in mind, and then work backwards from that. Use the online calculators to figure out how much to save per month assuming a certain rate of return I’m going to get on my money.
Are there any penalties if I don’t contribute regularly, stop contributing, or don’t use the account?
With 529 college plans, federally speaking there are no penalties to stop contributing or to not contribute regularly. Most plans out there allow you to contribute on your schedule. Many parents do it on a monthly basis right out of their checking account or a payroll deduction from their employer. But you could also decide to put in money every January 1st, and go ahead a do it each January. There isn’t set schedule, certainly no penalties for how you want to contribute.
Most 529 plans have a certain amount (required) to open the account. Here in Oregon, it’s $25 to open an account. Most plans have a certain amount, though it’s usually pretty low. Once you meet the threshold, you can stop contributing. Once you open the account with the requisite amount, you can do what you’d like.
On the other hand, for those folks who have been saving money in a college savings plan (this is a federal rule) and you decide I’m not going to use it for college. All the rules are built around future college expenses, so if you don’t use it for college it ends up being what’s called a “non-qualified withdrawal” taking it out for other purposes than college. At that point you’d pay taxes on the earnings of your account at your rate, because college savings plans allow for tax free growth. So taxes on the earnings (because you haven’t paid taxes on those), plus the federal government says, ‘because we’ve given you this benefit, we’re also going to charge you an additional 10% penalty on your earnings portion of your account as well.’ So there is a penalty for using it other than for college expenses. Most states don’t have additional penalties.
Can anyone make contributions to the account (grandparents, family, friends)?
I often make the joke, the best way to fund a college savings account is to have someone fund it for you. We really encourage parents to set the account up and then encourage family members to contribute to it. I have two girls, they don’t need any more toys or dolls, so when they have a birthday, I tell my friends and family get them a small gift and put $50 into their college savings account. That way not only does the account get my and my wife’s contribution every month, but also these extra little boosts over time. So we definitely encourage friends and family to put money in there. There is no restriction on that.
How important is a college degree in today’s society? It seems the investment may not be worth the return in today’s economy with student debt.
I’ll give you a statistic that we share with parents, because I get this question a lot. Especially from parents who didn’t go to college themselves and are looking to send their kids. If you have a four year degree, on average, you can expect to earn $1 million dollars more over your lifetime than someone with a high school diploma. So at the end of the day, not only is a college degree going to get you more money, but it’s also going to afford you more opportunities. So a person with a college degree is going to walk out of college with a vast array of opportunities where a high school graduate is going to have fewer opportunities and the earning potential is going to be a lot lower.
Because 529 plans require you to name a beneficiary, even though that beneficiary may or may not use the plan, you can transfer the money around. So we tell parents the money is not locked up for that beneficiary. If you have three kids and one doesn’t use it or doesn’t use it all, transfer it around so someone can take advantage of that tax free growth you’ve earned.
What happens if you don’t use the money for a college purpose?
The great thing about 529 college savings plans is even though I’ve saved for this beneficiary for 18 years and I’ve got a significant amount saved up, maybe that child decides not to go, maybe they get a partial or full ride scholarship, what happens to the dollars? The dollars can go toward anybody in that family.
Here are some examples: I could transfer to his or her siblings. If the siblings don’t need it, then transfer it to the children (born or unborn) of the child who didn’t need it. There is an ability to move this money from generation to generation and benefit those generations that are coming up. You don’t have to take it out and incur the penalties we talked about. Leave it in there for someone who’s going to need it in the future. You can’t skip over generations, but you can move it down. Grandparents could put substantial amount of money in there and then just let it roll down from their kids, to their kids, to their kids, etc. You can do some substantial legacy planning with these plans.
If I start a savings plan through my state’s savings plan and my child attends an out of state school, what happens to my money?
529 plans are based on federal code. States hook into the federal code, so at the end of the day you can go anywhere you want. It’s a common misconception that because it’s the Oregon College Savings Plan or the California College Savings Plan that I can only go to school in those states. It’s not true. You can typically go to any two year, four year, graduate school, vocational school, higher education, in state, out of state, and many schools abroad. So there is no restriction on where you can go.
If there’s money left over after graduation is the best option to roll it down as you mentioned earlier, rather than take it out?
While not giving any advice, at the end of the day you’re saving your money. If you don’t need it out for an emergency lets say and it’s still in there, you can do the next generation a real benefit by leaving it in there. It would be my recommendation, again not knowing personal financial situations at the time kids graduate, if you don’t need it, it could do some real good down the road.
How do you name a beneficiary if they’re not born yet?
Great question. So what you can do, lets say you got married and you’re planning to have kids in a couple of years but you really want to get a jumpstart on saving to be ahead of the game. You can open up a plan and name yourself as a beneficiary. So you’re the account owner and the beneficiary. Once that child is born and they get a valid social security number (which is essential to being a beneficiary. Being a U.S. resident or a resident alien and having a tax ID number or SS number) you can then call up your plan and say you want to transfer these assets to this beneficiary. So you can jumpstart your college savings by naming yourself as the beneficiary and then just rolling it over when your child is born.
Are there any restrictions for money in my savings plan? Can it be used for books, housing, general costs?
You can use college savings assets for tuition and fees, room and board expenses, living expenses, books and other required supplies for admission to that university. So what we tell folks is, when you enroll in a school you’re going to get what’s called the Cost of Attendance (COA) and that COA is going to say it’s going to cost $20,000 a year to go to school here all-in. As long as your expenses are meeting those costs you’re fine. You can pay dorms, meal plans, apartment if you’re living off campus, food if off campus, gas in your car to get too and from school. Any expense that requires you to be at that school and be able to function as a student would be a valid expense.
How do you access that money? Is it a transfer or can you give your kids a prepaid credit card?
This is where some states may differ. I don’t know what every state does as far as distributions. In Oregon we try to make it as easy as possible for you to take a distribution. We encourage families to have online account access to us. You can go online and we will wire the money directly to your school. What a lot of parents will do is say, ‘I want my kid to get $5,000. Please wire (electronically send) me $5,000 to my account’ then the parents send that money on to the kids via debit card or any other option.
You talked about the requirements as to what the money can be spent on, so once a dispersement is made, how can the government tell what it’s been spent on? Is it the honor system, through taxes, or some other way?
When you take a distribution, you are required to tell us if it is a qualified distribution (used for qualified college expenses) or a nonqualified distribution (not used for college expenses). We then report that distribution to the federal government through a 1099 tax form. However, there is no specific check on how the person actually uses the distribution. So it is on the honor system to some degree. The person is not required to submit any receipts or paperwork.
Why are 529 plans more beneficial than other forms of saving or investment?
The big benefit in 529’s is the tax benefit. Everything you earn in the plan, if you use it for qualified college expenses, all the earnings are state and federally tax free. So you’re not paying taxes on anything that you earn in the plan. There are also some states that have a state tax deduction every year for 529 contributions. So you can get an upfront tax deduction off your state taxable income, in addition to that tax free growth on the state and federal side. So you’re not going to find that kind of packaged tax benefit anyplace else for college savings.
What advice can you offer parents in terms of 529 college financial planning?
They’re really for that family who has some investable assets that the family can’t afford to just write the check at the end of the day for school. But they’re also that family that makes enough as a household that they’re not going to get a ton of federal or state grants. Many of the grants have an income threshold. These plans make a lot of sense because they do two things. One, the state is out there promoting college savings and education parents on what it takes to put your children through school. Second, they provide an easy investment vehicle to put your money in.
What would you recommend to parents to research before signing up for a plan in their state?
Savingforcollege.com is an non biased non-commercial website that does research on every 529 plan around the country and then posts it on their site. A great thing you can do is say ‘I’m really concerned about fees, I want to pay the lowest amount I can.’ You can click the button that says “compare fees” and it will show you every state’s fees. And you can look down the line and say I’m going to pick the one that has low fees and best returns. You can compare performance, or tax benefits also. I would advise parents to do your research and look at your state’s plan first. You can invest in another state’s plan, there’s no requirement on residency. That website will help you find out what’s important to you.
Finally, parents shouldn’t feel like they have to have the entire four years saved up. That shouldn’t be a barrier to starting to plan. The more you have saved up means less you either have to borrow or pay out of pocket when your kid is ready to go to school.
Have you started planning for your children’s college education? Share your thoughts below!
This interview has been edited for length and clarity.