I have five of the sweetest nieces and nephews on this planet ( #6 on the way!).
In addition to being immeasurably cute, they are proving themselves to be little geniuses. I can imagine one as a teacher, one a comedian, two as engineers, and one whose next ambition right now is learning to crawl. As I describe the little joys in my life, I am sure you thought of your own, and their incredible potential. You cannot create a perfectly smooth future for them, but there are measures you can take to pave the way. One of these measures is investing in their futures through 529 plans.
Here are 4 reasons why you should consider contributing to a 529 on behalf of the children in your life:
1. You could owe less in capital gains and state tax.
We pay a lot of taxes.
Paying taxes and monthly bills, on top of saving for important goals, like education, can be daunting. The government is aware of this fact and has created opportunities for average Americans to be more efficient savers. You don’t have to hire an expensive tax lawyer to uncover tax savings! Look no further than the 529 account.
When you invest in a normal brokerage account, growth is taxed at your capital gains tax rate.
So, if you sell stocks that have grown in value by $1,000, your tax bill will be between $0 – $200 depending upon your tax bracket. Each year, you also pay capital gains tax on dividends. It adds up! If you save for your niece’s education using a taxable brokerage account, you may not have as much money available as you thought come tuition time. However, when you invest within a 529 plan and use the funds for qualified educational expenses, you will not pay any tax on the growth or dividends! It can all go straight to tuition.
If that doesn’t convince you to use 529s, here is another great benefit. There are 30 states (including Ohio) that offer state tax deductions on money contributed to a 529 plan from their own state. Each state’s plan operates a little differently, so please research your options. Savingforcollege.com is a good place to start!
2. You’re likely to experience more growth over the long term.
I am not a betting woman, but I wager that you have heard discussion on the news of low interest rates and the possibility of rates dropping even more. While this is great for borrowers, it is not great news for savers. If you simply put education savings into a checking/savings account, or even a CD, you will likely earn anywhere from 0.1 – 2.3% (if you are lucky). Comparatively, an account diversely invested in the stock market is expected to average 7 – 10% growth.
Let’s look at this another way:
If you saved $10,000 in a bank with a 2% interest rate and didn’t touch it for 18 years, you would have $14,282.
$4,282 of “free” money is great, but you can probably do better.
If you invested that same $10,000 in the stock market averaging 10%, you could have $55,599 after 18 years. You well over tripled your potential end value with little extra work required of you!
Educational savings left in the bank is not only missed opportunity, it is lost value. The average cost of college inflates 8% per year!! This means that in just nine years, the cost of college could DOUBLE. If you have a fourth-grader now, a $35,000 tuition today could be a $70,000 tuition by the time they get to college. Your bank savings simply will not keep up.
A 529 is a simple way to invest in the stock market and potentially have tax free growth. The market does carry certain risks, so I encourage you to talk to a financial advisor to ensure you are invested appropriately.
3. There is more flexibility than you might think.
To any of my homeschooling friends out there, did you know that you can use a 529 account to pay for homeschooling expenses? This means that by contributing to and drawing from a 529, you could receive tax savings on expenses that you would have paid for anyway! You can also use up to $10,000 per year to pay for K-12 private schooling for your children.
Of course, once they are college age, the 529 accounts can be used for trade schools and most any undergraduate or graduate program. Because of the SECURE Act that was made effective in 2020, you can now use 529s to pay for state registered apprenticeships AND for paying up to $10,000 of student loans.
Yes, that means you can graduate with student loans, work and put savings into a 529, and then use the 529 to make student loan payments AFTER graduation.
Kids grow up in a flash. Their minds will change many times on what they want to do when they grow up. A 529 can allow them the flexibility to use the money to be anything they want, whether it’s being a teacher, trained electrician, or a doctor.
4. You can transfer accounts to other students… or yourself!
So, what if your son grows up and doesn’t want any further education at all? What if he earns a full scholarship or joins the military? Don’t worry, you are not stuck!
If a student no longer needs a 529 due to a scholarship, you can take the money out and only pay tax on the growth (just like a regular investment account). No penalty is associated.
Alternatively, you could transfer the 529 account to another related student. If your son doesn’t need the money, it’s likely your daughter or future grandchildren will. Or, you could even transfer it to yourself for your own professional or graduate studies!
Lastly, if you truly have no educational need for the money in the 529 account (very unlikely), you can withdraw and use it for any purpose. You pay a small penalty and taxes on the capital gains. Your actual contributions will never be taxed again or penalized.
Higher education is expensive and inflating quickly. You cannot control the expense, the economy, or your children’s career paths, but you can provide a foundation for sending your kids out into society better prepared: with less debt and more education. A 529 plan can help solve a lot of problems, but it is not right for everyone! Prioritize your goals, talk to an advisor, and do your research, because it just might be right for you.