AN IDEA FOR “OLDER” PARENTS WHEN SAVING FOR COLLEGE EDUCATION: ELIMINATE THE “ELEPHANT IN THE ROOM”Submitted by William Allan Financial Services, LLC on August 25th, 2017
The rising cost of college tuition has prompted many parents to wonder aloud how best to assist their “little ones” in achieving their college dreams without being saddled with debt after college. The common conclusion… Stuff as much cash as humanly possible into those “wonderful” 529 college saving’s plan(s)!
Outside of the fact that these plans are state sponsored, have minimal investment options, and are not the “cheapest” investment vehicles, there is ONE big overwhelming concern about the use of the 529 plan… “What if Junior does not go to college!?!?!” And so the plot thickens…
Before we move on, to answer that question, when withdrawals are made from the 529 plan that are not used for education expenses, you will pay income tax as well as a 10% penalty on any gains in the plan. Ouch! For our “older” parents (with newborns in the house when you are at least in your late 30’s) we have a suggestion to avoid the potential pain (i.e., taxes) from Junior’s inexplicable action(s).
As an older parent, your child most likely will not graduate college until you are age 59 ½, the age when you can access your 401(k) plan without having to pay a penalty on withdrawals. Therefore, why not use your 401(k) plan as the savings vehicle for college savings rather than the substandard 529 plan?
Here are the two main benefits of a 401(k) vs. a 529 plan:
• 401(k) contributions are tax deferred ($18,000 annual limit, $24,000 if you are age 50), and
• If your child does not go to college you are not going to pay any penalties.
I know what you might be saying… “I thought my 401(k) was for retirement. Why are you trying to make me use it for college education.?” Well, in my experience, most people do not contribute the annual maximum to their 401(k). Therefore, there is room for additional contributions for the college fund.
In addition, if you happen to fully fund your 401(k), you still have room to contribute elsewhere. Here are the retirement account(s) with their maximum contribution limits, in order of how we suggest you use them:
1. 401(k) - $18,000 ($24,000 when age 50+)
2. IRA (ROTH or Traditional - $5,500 ($6,500 when age 50+)
At a minimum, you can contribute $23,500 ($30,500 when age 50+). Now factor in if you are married and your spouse works those figures can double. And if he or she does not work, you can still do a Spousal IRA, so adding $5,500 ($6,500 when 50+) to the total. So, at a minimum, a couple can contribute $29,000 annually to retirement accounts ($37,000 when age 50+). As an “older” parent, not until you reach these saving levels should you even consider a college savings account.
So, to recap:
1) Max out your retirement account(s) before even considering a college savings plan,
2) This approach will get you the best tax break (529 plans are funded with after tax money),
3) The investment options in retirement accounts are generally better than the 529 plan options, and
4) Most importantly, Junior’s decision to forego college for a band will not cost you (at least financially) any anguish!