How to Earn an Instant 7% Return on Investment
I have five children. It's a lot. And I've struggled, since they were little, with how, or even whether, to save for a college education for each of them. Their dad and I agreed long ago to contribute up to half of their annual education expenses, with a match of 10 cents on the dollar for all scholarships earned. And now, I have one graduated from college, one a senior, and one a freshman. The picture is changing from saving to paying for college.
Enter the #529Plan. Investing in this plan in particular did not make a whole lot of fiscal sense to me early on. I questioned, as many FI bloggers have, why I would want to invest in a dedicated college savings plan when there are other vehicles available for saving and investing, which did not lock me into a lifestyle or university choice. I questioned why I would want to use a state-run investment platform that may or may not offer investments I even liked, let alone trusted. Maybe the expense ratios were high. Maybe the returns were low compared to the cost of college tuition inflation. If my current state of residence offered a pre-paid tuition plan, maybe I wouldn't even live nearby by the time the kids reached college, and would have no incentive for using those credits. To complicate things, I lived in WA for a while, and then overseas, while the majority of the kids were little. Neither of these locations has a state/local income tax. But once I moved back to the US, I realized that a 529 Plan in my state was a lucrative way to whittle away at the state income tax portion of my annual tax burden, especially in the very near term.
After maxing out the 401(k), the HSA, and any other pre-tax savings vehicle, the 529 is the way to go if:
AND
Consider further that if grandparents, aunts, uncles, or anyone else has a large gift for your child, this deposit, if made by YOU (the state taxpayer) reduces your state income tax burden. This is especially true in the years when your child is actually attending a university. In my state, there is no rule about invested 529 money spending any particular amount of time (aging) in the 529 Plan before it is removed for use. Effectively, I could have saved money in a ROTH for years, withdrawn the principal penalty-free, deposited it into a 529 Plan, and recouped the state income tax I am currently paying on earnings. For a $10,000 deposit into a ROTH and subsequent roll through a 529 Plan, this is a refund of $700 when I file my state income taxes.
My family likes to use this method for all the nieces and nephews in the family as well. We are firm believers in keeping money in the family to the extent possible. When relatives live in income-tax-free states, they ask me to set up a 529 account in my state, "gift" me the money (below the federal gift tax rate, to avoid triggering that), and I "gift" it back in the 529 account for that child. This saves me 7% income tax on those gifts, because I can write off ALL deposits for ANY child, as long as I am the account owner. If my family were to give the annual limit to me and my husband, $30,000, and I deposit it into a 529 Plan, I receive $2100 back in state income tax when I file. My money doesn't even have to earn any interest or spend any amount of time in the plan for this to work!
Another money-shifting method I've been using for my college-age kids, because my family has relatively high medical bills to justify this, is a roll through an HSA. My husband is employed, and his employer offers an HSA medical plan. We deposit the max into the HSA, withdraw money justified by healthcare expenses, and subsequently move that into the 529 Plan. This method not only saves TWICE on state income tax (tax-free going into the HSA, and tax refund going into the 529), but shelters the 529 deposit from federal taxes, simply by taking advantage of the fact that we would have spent money on healthcare anyway. The HSA, while limited in total dollars allowed to be invested each year, is a FANTASTIC way to invest for college, retirement, or other future expense. Every person eventually has medical expenses, and because ours are in real time, and I have kids currently attending college, moving money from the HSA to the 529 Plan works well for me.
Perhaps you don't have any children - you might think this information doesn't apply to you. However, if YOU are attending college while earning income in an income-tax state, as many of us have, and if you are living in a state where the income tax rules for 529 Plans are lucrative, consider using these techniques for yourself.
When considering whether or not to use a 529 Plan for yourself or a child, it seems that the largest deciding factor is state income tax and whether the 529 for your state offers any income tax incentive. Your personal timeline should also be considered. I am not convinced that the 529 Plan is the best savings vehicle if you have 18 years ahead of you before worrying about college, but if your child is in high school, or your child is IN college, this is the perfect time to consider funneling money through a plan which will offer you a break on your state income tax for expenses you know you'll be paying anyway. Check out www.savingforcollege.com now and see what a 529 Plan can offer you! Perhaps you also will receive an instantaneous 7% return on investment!