Why I Don’t Have A 529 For My Child
A lot of of my physician colleagues tout the benefits of a 529 plan. So do a lot of personal finance bloggers. But I don’t have a 529 for my child.
Don’t worry, my wife and I are not expecting my daughter and any of our future children to fully pay for their own higher education. Of course we want our children to have a solid financial foundation. We definitely don’t want them to worry about having a heavy student loan burden.
I remember all too well how stressful that burden can be. And while I did a decent job of re-framing my mind into thinking that living frugally and rapidly paying off my loans was fun, there were plenty of other valuable things I could have spent my hard earned money on.
Even though my student loans are completely paid off, my wife still has over $200,000 in student debt from law school. It’s a burden that we bear together. We definitely have a plan for eliminating her debt too (hint: it involves loan forgiveness), which I may detail in the future.
Simply put, dealing with student loans is not fun.
Because of this, my wife and I plan to help our child(ren) pay for college. I’m just not convinced that investing in a 529 plan is the best option given our current situation.
What is a 529 plan?
Before taking a deep dive into why I don’t think a 529 is a great idea for us, let me provide a brief overview of what a 529 plan is.
A 529 plan is an education savings plan sponsored by a state or state agency.
529s are named after Section 529 of the Internal Revenue Code (IRC), which was added in 1996 to authorize tax-free status for ‘qualified tuition programs’.
If you invest in your own state’s 529 plan, you may be eligible for a tax deduction or credit. But you don’t have to invest in your own state’s plan. In fact, some states have better plans than others depending on investment fees and options available.
For example, a person from California can invest in a Utah 529 plan for a child who may eventually attend a university in Massachusetts. And since 2018, a 529 can be even used for eligible K-12 institutions.
Contributions in a 529 plan are made after-tax. Then, growth is tax deferred and withdrawals are tax free. That is, as long as it is used for qualified expenses. These include:
- Tuition (this one is obvious)
- Room and board (however, you can’t go too crazy with this and rent a luxury high rise condo since there is a budget limit set by the school based on local estimates)
- Technology items (such as a computer)
- Books and supplies (the estimated budget for this is also set by the school)
Some folks think of 529 plans as sort of Roth IRA used for educational expenses. This is because of tax free growth and withdrawals on qualified expenses. Sounds pretty good, right?
So Why Don’t I Have a 529 Plan?
There are several reasons that we’ve considered.
1) Paying off debt is more of a priority
My wife’s law school debt is priority #1. This takes precedence over everything else.
While I don’t consider myself particularly debt averse, most people would agree that $200,000+ is a lot of money. And when you consider that the interest rate on those loans is between 6-7%, it makes financial sense to get rid of this debt as soon as possible.
In about six years, we expect my wife’s student loans to be gone via public student loan forgiveness.
2) No State Tax Credit or Deduction
I live in California. The weather is great, there’s plenty of fun things to do, our families are here, and I can’t imagine living anywhere else in the world.
But we pay dearly to live here. California is notorious for a having a high cost of living and high state income taxes. It’s really a financial double whammy.
And while many states offer a state tax credit or deduction if you contribute to a 529 plan, California does not.
If I lived in a state offering a tax credit, then it’s a no-brainer. Of course I would contribute to a 529 plan. I’m not going to pass up free money!
3) No Tax Loss Harvesting
As a high income earner, I pay a lot in taxes.
One of the ways to reduce our tax burden is through tax loss harvesting. After offsetting any capital gains, tax loss harvesting can allow me to deduct up to $3,000 a year from my ordinary income. Not a bad deal.
Another potential way to minimize taxes is by donating appreciated shares.
All of this can only happen in a taxable account, and not in a 529 plan.
I’d rather take the tax break now as a high income earner in the highest marginal income tax bracket.
4) Less Flexibility
With a 529 account, it only makes sense to use the money for qualified education expenses. Otherwise, if withdrawals are made for non qualified expenses, then you’d have to pay ordinary income tax and a federal penalty of 10% on the investment earnings. On top of that, California imposes a separate earnings penalty of 2.5%!
Ouch. Why California? Why?
In addition, there are limited investment options with 529 accounts and management fees can be relatively expensive.
Clearly, with limited options in terms of investments and the ways in which you can spend the money, 529 accounts are not very flexible.
On the other hand, a taxable account allows me to minimize taxes now, invest in whatever low fee funds I want, and the flexibility to spend the money however I please.
5) Can’t Predict the Future
The truth is, we can’t predict the future. I don’t have a crystal ball.
Perhaps my children won’t even go to college. Maybe they will forgo the traditional route of attending university and start businesses as entrepreneurs.
Or maybe fifteen years from now, college will be completely free for everybody. Of course I highly doubt it, but you never know.
What if I need the money for something else? Maybe in the future, the government gets rid of public student loan forgiveness and decides not to grandfather people in. I don’t think it’s going to happen, but it’s certainly within the realm of possibilities.
I don’t like the idea of tying up a lot of money in a 529 plan when the future is so uncertain.
Final Thoughts
Currently, we don’t have a 529 account for our daughter.
Everybody’s situation is uniquely different. And as the saying goes, personal finance is, well… personal.
For us, getting rid of my wife’s student loan debt is a much bigger priority than funding my daughter’s 529 account.
Fortunately, my wife’s loan balance will be gone in a few years. And when that happens, it’ll be time to start funding a 529 account for our daughter (and any other children we may have in the future).
We certainly don’t want our children to go through the stress of worrying about student loans like we did!
Great points DMF. Ouch on California. Didn’t know they didn’t even give a credit for 529 contributions.
I always advise that if you have limited money it should go towards your retirement plans first before thinking about kids educational costs. Worse case scenario a child may have to get a student loan but at least they can get one. If you neglect your retirement funds and your own financials, you may find yourself out of money in retirement and the ability to get a loan at that age with no income will be next to nil. You will be far more of a burden to your kids in that scenario than the burden of college loans.
Ideally you can do both, but if resources are limited, best be selfish and direct them to benefit your own financial status before concerning yourself with your kids. And you hit it on the head, you can’t predict the future. Of course you can designate your 529 balance to a different beneficiary if the original intended one does not use it.
Thanks for chiming in, Xrayvsn! I always appreciate your input. Great advice in taking care of our current financial status and our retirement first. Gotta put your own oxygen mask on first!
Sweet post, Doc. I also weighed the pros and cons and settled on funding a 529 (just a bit) and paying off the remainder of my student loans from business school. I’m hedging myself both ways. I plan on emphasizing the importance of scholarships 😉
Thanks, Moose! Yeah, I was going to add another section emphasizing the importance of scholarships too! Eventually, I will start a 529 plan for my daughter. But I intend on funding ALL of her college expenses. She needs to have some skin in the game as well!
Both my wife and I earned scholarships for college. Hopefully my daughter can too. My wife was also really great at entering essay contests and earning college money that way. It’s almost like freelance writing in high school that you can actually get paid for. I’d encourage my daughter to do that as well. It would encourage her to write more, which is such an important skill.
I never entered those essay contests because I wasn’t that great of a writer. I’m still trying to learn and improve :).
I had no idea about California either. As a person who has lived in both places, if it wasn’t for family, I still think Seattle, Washington and Oregon have similar enough weather to justify the move! My sister-in-law has 2 kids and she’s doing their 529 and their own retirement account as far as I know. I don’t think I would contribute to a 529 either only because I don’t think “higher education” in the form we know will exist in the future (with that price tag.)
I totally agree with you, Lily! I have no idea what “higher education” will look like in the future. The world is changing and evolving in an ever so rapid pace. Who know what anything will look like ten or twenty years from now 😀
I think the 529 is a racket. Isn’t it strange college expense grows at the same rate as a typical 529. yet you are severely limited to spending money on what “the school” says you can. You think maybe the college accountants figured this out? It’s a locked in wealth transfer from you to the school, bend over and spread em. The college gets all the dough, the kid gets a 4 year drunk and a piece of paper and you get hosed. You fall for it because of the “tax dodge” and your inability to make a decision. What if Jr get’s into Harvard!!? You get the same dodge funding a UGTM and that can be spent however it needs to be spent.
My state has a tuition plan that pays for 120 credits and fees at any state school from the flagships on down. The kid can go any time. If you don’t use it you can get a refund of your initial investment. So if you buy this plan day one your kid has college covered. I bought one each for my kids cost $22.5K. You don’t need to carry a boat lad of life insurance “for college”. It limits the choices, BFD. It also limits the risk. Math is math and chem is chem and you can go anywhere with the degree like medical school, just kick butt on the MCAT. Next I funded a UGTM at age 2 with 20K put it in Vanguard and let it grow. So for 42.5K my kid was covered for college. I did it twice one for each kid, so net outlay was 85K for 2 college educations. The UGTM was efficiently invested so I paid nearly zero in taxes and at 18 the money is theirs and taxed at their rate. The UGTM grew from 20K to a little under 80K in 20 years and I doled it out like a 4 year retirement. Pulled some out each year and let the rest ride. The money paid for housing clothes electronics vacations a semester abroad a tour of Italy with my kids choral group and I spent the last of it to buy her a car and get started in her life. The money was hers at 18 but I never told her it existed just used it for her benefit till it was gone. I retired in the middle of #1’s college career and her cash flow did not affect my cash flow.
Were it me I would fund college with a wad at age 2 in this manner and let the investment growth do it’s thing and then pay down the student loan. The loan is a nuisance despite hat Dave friggin Ramsey thinks for someone with your kind of earning power and college expense is going to continue to grow far longer than the life of the loan, which will be a memory when you kid starts college. Also with your kind of earning power she isn’t qualifying for anything. The best thing you can give her is a debt free start., otherwise she doesn’t stand a chance. I paid 42.5K and reaped well over 120K worth of benefit from the maneuver plus the kid’s college was covered from day 1 no paying Warren Buffet for the privilege of his insurance. I think you can stash about a 28-30K gift these days without mucking up your own tax picture.
Thanks for all the great info, Gasem! I don’t think California has a similar tuition plan, but I’m not sure. I should look in to it.
I’ll probably end up finding a small 529 for the kids. But I’m definitely not going to overfund it.
I like the idea of funding a UGTM for each kid too. I’m betting that my wife and I will raise financially responsible children… so I don’t mind all the money going to them when they come of age. And like you, I probably won’t tell them it exists and just use the money for their benefit when needed.
Just curious, why fund the UGTM at age 2 and not sooner?
My kids are adopted and were about age one when we got each of them, 12 mos for #1 and 14 mos for #2, so I had to eat the adoption cost the first and third year, figure out my plan and fund college on the second and 4th year. 20 years later it worked out great. Plenty of money for a rich college experience with no hit on my cash flow. Kids graduated debt free and with a car. I also had a loan aka a mortgage which I paid concurrently and didn’t get all bent out of shape Dave Ramsey style trying to get debt free as it was low interest tax deductible property backed money into an asset. I just let that crank turn while I planted the rest of the financial garden. Eventually I paid it off early but not till after everything else was busily compounding away.
Planning something like this is like writing computer code. You do it in modules, each module accomplishing it’s task and finally modules are added together to form a complete program. Each module has it’s own efficiency and optimization and then the sum of the modules has its own efficiency adjusted. By doing it this way all of the contingencies get covered and the perverse over optimization of one module is not allowed to over power the optimization of whole project. Finance has a limited number of modules (portfolio, loan repayment, college saving, budget, income sources, taxes, insurance) so the degrees of freedom are also limited meaning it’s not really that complex to optimize. What is often missed is the time value of money. The sooner you fund something the longer it has to compound so much less is need to reach a goal. My college plan is the definition of this thinking.
1 Buy tuition age 2 (locks in tuition cost)
2 Fund UGTM ( locks in compounding) projected doubling every 7 years
3 Wait 16 years
4 Execute college freshman year at age 18 withdraw some UGTM let the rest compound
5 Execute college sophomore year at age 19, withdraw some UGTM let the rest compound
6 Junior year, also funding semester abroad
7 Senior year funding Italy choir trip and a car on graduation.
Risk: at some point she may run out of money but we’ll cross that bridge when it happens
20K @ 6% for 16 years is $51K, withdraw 10K yr 1 and let the rest grow leaving 41K
you can then pull out an additional 10K for 3 more years leaving 18K to spend for trips abroad and car. The college has no say in how the money gets spent. FLASH: If you bought her $20K of BRK.B at age 2, it has an expected return of 12% let it grow till she is 52 then tell her about her account, which would have 5.7M in it. Nice 52nd b’day present. BRK.B is opaque to taxes. Include knowledge of the account in your will in case you kick before she turns 52. Time value of money. This is why I don’t believe in Dave Ramsey’s BS
Thanks again for your thoughtful comment. You and Vagabond definitely have things figured out. I’m definitely using this plan as a blueprint for how I would like to get my children set for life.
Your reasons are solid and you should focus on paying down that debt. If I were in your situation I would be doing the same thing.
I think the house of cards that colleges have built with outrageous tuition is going to crumble. Pressure from open learning, the internet, and other forms of education are already making themselves well-known, and it’s only a matter of time until people wake up and realize it isn’t worth it.
Yes, I was thinking a lot about how in the future there will be more open learning and other forms of education. Who knows what education will look like (or how much it will cost) in the future.
I agree in addition to these reasons, you can withdraw funds from a ROTH for educational expenses without tax penalty.
Very true!!! But I’m hoping to let my Roth grow undisturbed and let that money grow tax free as long as I can.
Yes, we have, in addition to large 529 balances, which will completely cover college expenses, separate UTMA accounts with north of $100k, to assist the two children (17 and 20) to get set up in life. Having these assets set aside, and not included in our own calculations, gives us the freedom to pull the retirement trigger whenever we want. In other words, the 529 plans have worked well for us.
Wow, both you and Gasem have done a fantastic job in setting up your children for life. And it makes sense that with these accounts well-funded, you will have no worries pulling the trigger on retirement. Many of my older colleagues can’t quite retire yet because they are stuck paying for their childrens’ college expenses and beyond. Having children on the payroll can get pretty expensive! My goal is to have well-funded accounts for my kids in 20 years. You and Gasem are great role models!
We have done the same. Fully funded retirement and 529. We invest outside as well. It’s all about having a high enough savings rate and still working. Plus we have hobbies that don’t cost anything! I beach walk and pick up plastic along the ocean and yesterday I found a penny!
I don’t have kids, so I never had to consider this. But when we thought we might.. The idea of a 529 scared me because, like you said, there’s no telling what the future will bring. What if your kid is terrible at school or just decides to go for a trade instead of a white collar career? It seemed like a gamble, though a tempting one, tax-wise.
I think you’re making the right choice to pay down your debt first.
Thanks for stopping by, Abigail. Yeah, for now I’m not going to fund a 529 for my child. But once our debt is fully paid off, I probably will. If my kid goes to a trade school I can always change the beneficiary to another kid or a grand child :).
Awesome points and thanks for reinforcing my decision! We didn’t open a 529 for my son soley on the fact that we don’t know what college is going to look like in 16 years.
We also have my GI bill to transfer wich is a huge military perk. Opening a taxable brokerage account or “employing” my son and starting a Roth IRA. Would be better decisions for sheer flexibility. Taxable brokerage accounts aren’t nearly as scary when you factor in capital gains harvesting. That is quite frankly my favorite rule we learned in our personal finance experience.
I really agree with your first point too. When the oxygen masks drop, put your mask on first. No decision is a bad decision in this case but you definitely did the homework for us. Thanks!
I am iffy about contributing to a 529 as well. I don’t get a tax benefit for contributing and I too am unsure of the future of my kids, college, etc. I’m leaning towards cash flowing if or when the time comes. California State schools are so cheap (relatively speaking) that I’d have no problem cashflowing them. I know many people who paid a ton for out-of-state tuition just to attend school in California, you should feel fortunate to get in-state tuition.
I know this is an old Post but I couldn’t disagree more. We got two 529 plans in VA for 16000 each and refinanced our house to start 529 investment plans. Kids are almost though college haven’t cut a check yet. It’s been a lifesaver.
You give the penalities for making unqualified withdrawals as a reason to not get a 529. That’s ludicrous. Here’s an idea. Don’t make unqualified withdrawals. Why would you want to anyhow ?
Our plan is flexible. Transferable to other kids. Can be used for post graduate or even trade or vocational school. It’s certainly more flexible than a utma.
I wouldn’t do a 529 prepaid plan now because they are too expensive. But if you got in at the right time, it was a no brainer. I wouldn’t have cared less if I had debt to pay off.
Thanks for stopping by. Yeah, I agree that if I had a 529 that wouldn’t make unqualified withdrawals.
Everybody’s situation is different. And everybody’s debt tolerance is different too. In my case, I would rather wait until my wife’s student loans are completely paid off prior to funding a 529 for my child.
We have 529 plans for both kids and almost fully funded. We plan to fully fund undergraduate and help out with grad school but not fully fund. I can see your point of view. When we graduated the treasury bill rate was very low and we consolidated. We are almost done paying off our loans but it’s at 1.8% so we are in no rush. For us it was a way of forced savings.
Good reasons. We have two, one for each child. First one is about $300,000 and the second one is worth about $200,000, I’m worried about college tuition 14-16 years from now so we invest.
Further, we will probably open up more 529 plans for generational wealth transfer purposes.
Sam
Thanks for stopping by, Sam. I am a frequent reader of your site for financial knowledge and insight. I think you are doing a terrific job of setting your son up for financial success. Thanks for being a great role model as a father.