In this episode we are going to be discussing the top two ways that you can save for college. Specifically we will be discussing mainly the use of 529 plans and taxable account also known as a brokerage account.
Before you can start saving for your children’s college fund, it’s important you’ve already done the following:
- Paid off any debt (this includes things like your credit card debt, your own student loan debt, etc.)
- Set up an emergency fund of a minimum 3 to 6 months of expenses to cover any unexpected costs. Might consider 12 months. The exact number depends on your individual circumstances and comfort level. How stable or unstable is your employment, source of income (i.e. varied or steady).
- Put 20% of your income toward retirement savings through your employer-sponsored retirement plan, like a 401(k) and/or a Roth IRA
Also, you need to figure out how much you need to save for college. If you have a spouse what do you plan on paying for your child(ren). I.e. the tuition costs, textbook fees, rent, food, etc. Will you have a limit. Things conversations will probably be ongoing but you need a framework and a guide to come back to.
- A 529 college savings plan is a tax-advantaged account where you can save and invest money for future college tuition and qualified costs.
Benefits of using a 529 plan
- Set aside after-tax contributions that grow tax free, similar to a Roth IRA but with much higher contribution limits.
- Funds in a 529 plan are exempt from federal taxes if the funds are used for qualified educational expenses. Such as tuition, room and board, and books. That doesn’t include general living expenses and buying a car for college. Such non-qualified expenditures will be taxed — and accrue a 10% penalty.
- Also includes K-12 tuition in Iowa at public, private or religious schools up to $10,000 per year per student
- Friends and family members are able to make gift contributions to your account for birthdays, holidays or any other given time.
- Option to change the beneficiary to another family member.
- Can invest in similar funds you invest for your own retirement. I.e. target date, lifecycle funds,
- Usually need very little to get started. Iowa 529 is $25.
- Iowa’s website.
- Anyone can open up an account
- Go directly to 529 Plan
- Use Ugift to have family/friends contribute
- Low cost at 0.2%
- Use Age-based tracks. Similar to Target Date Fund
- Uses Vanguard Target Date Funds
- Avoid using a broker as that will cost you additional unnecessary. A broker is not the same as financial planner.
- Higher contribution rates (varies by state, but generally you can contribute up to $300,000)
- Most of the time, there aren’t any income limits or restrictions based on age
Drawbacks of using a 529 plan
- Have to use them for qualifying educational expenses to be able to reap any tax benefits
- Pay taxes and a 10% penalty fee on any earnings you take out and don’t use for qualified college expenses.
- 529 funds count toward that child’s assets and Expected Family Contribution (EFC) calculation for financial aid. Depending on where you live, this could prevent students from receiving need-based aid
- Some states 529 plans have high investment fees and limited options to invest in. Iowa’s 529 plan is good.
Brokerage accounts give you access to any investment that you’d like to buy or sell. Great option is Target Date / Lifecycle Funds. A [ place like Vanguard, Schwab, or Fidelity have some good options.
- Deposit and withdraw money at any time without penalty. Similar to savings account but have access to funds with higher returns.
- Can use if not attending college
- Wide access to investment options at very low costs
- Vanguard Target Retirement Fund
- Minimum of $1,000 to open. Expense ratio is 0.13 to 0.15
- Schwab Target Index Fund
- Minimum of $100 to open. Expense ratio is 0.08
- Fidelity Freedom Index Fund
- No minimum. Expense ratio is 0.14
- There are no tax advantages associated with brokerage accounts. You’ll also be responsible for capital gains taxes if your money earns a return
- You may be hit with brokerage account fees, such as management fees on the account itself. Additionally, depending on what you invest in, you may incur commission fees, too.
- You may be required to make a minimum investment to open a custodial account. This would mean needing to start saving before even beginning to put your funds in a designated account.
Call to Action:
- What way are you using to save for college currently? How did you arrive at that decision? Are you putting your retirement savings first?