529s Are Great But…

529s Are Great But…

Thanks to Professor FI we have a solid plan to load up our 529s and a calculator to match so we don’t over deposit. Which brings us to my next thought on the subject…I hate 529s…

As we all know I have a habit of being dramatic and while I do have a 529 plan for each child I can’t help but not like the system in general. I do have to say that 529s are a great way to help parents and grandparents plan ahead for college (sort of).

The Paradox Of Choice

One of my beefs with the 529 is the fact that every single state does theirs differently. That is because the states are the entities that oversee the 529s. With a traditional IRA or Roth IRA you go directly to a brokerage like Vanguard or Fidelity and work with them. The rules for those plans are set by the federal government and maintained by the IRS. With 529s your money is housed by a brokerage firm but ultimately that is linked back to a state who determines the rules.

This makes it difficult to shop around because you aren’t comparing apples to apples. Certain states offer incentive programs like tax breaks (only for residents), contribution rules are all over the place, some hook up to different giving programs like UGift, and the fee systems vary as well.

Here is the part where you say, “Oh come on. At least there are only 50 states.”
…Nope. It is very common for a state to have multiple 529 plans with different rules and fees. Colorado and Nevada have four each!

States have to be competitive too so their rules are ever changing. (segue)

The Ever Changing Rules of 529s, Who You Going To Call?

Let’s say you are a parent that wants to open a 529 for your children, where do you start? I was stupid enough to have a “financial advisor” (who was not a fiduciary) help us start one. He put us in what is considered one of the worst ones because he got the most kickback from it.

This brokerage house was also kind enough to charge us a $100 fee to move our money out of their system. You know… “stealing candy from a baby.” The move took us nearly two months to complete the transfer because they kept changing what we were supposed to fill out to make the transfer.

I would suggest Googling but the problem is so much of that information is out of date. It took months for the rules for Minnesota to be updated after they signed them into law (we only have one plan too). I ended up having to read the actual law to try to get some answers out of it (still not sure on some of the particulars).

Needless to say, personal finance blogs are your best bet to figure this stuff out. These people read this stuff for fun and then break down the major points. You just have to double check with other sites to verify the 529s haven’t changed since the post. I used Mama Fish Saves to settle on a plan for Mini Donut and used Vanguards awesome (but sometimes out of date) tool to figure out for Babe.

Although, having a 529 is half the battle (segue again).

Pulling Money Out

Ultimately, 529s have to have basic sets of rules for the IRS to acknowledge them and they operate much like the Roth IRA. You put in post-tax (sort of) money and then it grows tax-free. Just like a Roth, you may also pull out the principle without a penalty. The problem here is a good helping of states offer tax discounts for contributing to a 529 plan. That means check your rules carefully to make sure there aren’t tax issues on that money with them.

Let’s say you don’t plan to pull out the principle unless it is a qualified educational expense (because that makes life easier) and then let’s say your child doesn’t use all of the money in the 529. That money is now trapped in the 529. Most like to spin it saying the 529’s money can be switched over and used for the parent’s education or even the kids of the child that just went through school (there are other relatives that count but not the point). At no point are you allowed to take the leftover money and roll it over to a retirement based account. You HAVE to use it for education, pay a penalty, or leave it in the 529 hoping someone will use it someday.

Plan To Contribute But Hope For Change

My parents showed me the importance of higher education and I want to be in the position to help my kids get an education and not be saddled with the debt of it. 529s allow me to do that but not without careful planning so we don’t over contribute.

I could forgive everything about 529s if they changed that simple rule. If you really want to help a kid start life off right you help them pay for some schooling and then jump-start their retirement with the leftovers.

14 thoughts on “529s Are Great But…

  1. With two young children, 529s have started popping up on our radar again recently. Yet, I get a little wary with all of the rules of extraction and don’t want to have my $$ trapped unnecessarily. So, it definitely warrants further investigation, although we recently hired a wealth manager, so maybe I’ll let them do all the specific research as it applies to us. 🙂
    Michael @ Financially Alert recently posted…8 Millionaire Habits that Will Feed Your FIRE

    1. No idea what a wealth manager job entails but sounds scary. I blame that financial advisor that wasn’t a fiduciary.

      529s are something to be strategic with. Good luck.

      1. Always look for a fiduciary advisor. If they aren’t working in YOUR best interest, then they’re either working for their own or for their firms. Do you want someone to maximize your gains or their own? Yeah, me too. 🙂

        While I’m biased, I also recommend looking for a fee-only advisor. That is someone who does not get any sales commissions or incentives. There is no benefit to them for suggesting one investment or insurance product over another – they’re more likely to put you in the lowest-cost most-appropriate product when that conflict of interest doesn’t exist.
        Brad – Financial Life Planning recently posted…Why You Need To Understand How Mortgages Work

  2. Nice post. We ended up in a plan sponsored by the state because it made the tax credit more clear. We are on track for about 50% of our savings goal in the 529s. When daycare ends and we get our “raise” from that, we are planning just a post-tax investment account for the other half. Our college savings rate will have already maxed out the state tax credit on the 529. Yes, the growth in an investment account is taxable, but we view that as something of a “fee” for the flexibility of not having our finds stuck in a 529. Not an ideal solution, but trying to balance the benefits vs. lack of flexibility in 529s isn’t obvious, at least to me.

    1. I plan on opening a Roth for my kids as soon as they start working and doing a matching program for them to really feel the importance of saving. We can always pull some of that money out if we need it.

      At some point we will start some UTMA brokerage account. Not sure when. Post daycare would be a good time though.

  3. We used our state’s 529 because of the tax cut.
    If you have any question, just call the company that runs the 529. They are usually pretty good. Or call your state’s 529 office.

    Last year, we transferred the total over to Vanguard. You can’t go wrong with them. You can read more here.
    http://retireby40.org/moving-oregon-college-savings-plan-529-vanguard/

    This year we’re contributing to the Oregon plan again so we’ll get the tax cut. Now we have a plan in Oregon and a plan with Vanguard. A little complicated, but it works very well. Best of both world – tax cut and low fees.

    1. Yeah I love that we have one kid with Vanguard and the other with Minnesota. I do like that you can be with other state’s programs and aren’t locked into your own.

  4. We just planned to cash flow our three kids through college supplemented by savings in non-tax advantaged accounts. I’m glad we did since all three got 100% free rides for their 4 year degrees and paid for their advanced degrees themselves. We would have had to take the penalty to ever get that money back since neither me or my wife intends to get additional paid education now that there is virtually unlimited free education available. Also we do not intend to pay for college for grandkids, that’s our kids job.
    Steveark recently posted…The Financial Marathon

  5. And this is why we did a Coverdell ESA for our child. They do have a lower cap on what can be contributed and it is all after tax dollars but the Coverdell can be used for any education expense, K-12 or College. Our philosophy is we will help some college, but not pay for all of it. So this worked best for us.
    Still, like you, I hate them all!

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