With the holidays coming up, lets think about how to gift the children in our lives something that will contribute to their future financial freedom rather than a toy they will forget about in a month or two.
According to a 2018 report by the Federal Reserve Bank of New York, nearly 45 million Americans have student loan debt. As a parent, Aunt or Uncle it’s natural to not want the children in your life to contribute to that because they want to further their education.
I personally contribute to 529 accounts set up accounts for my niece and nephew, every birthday and Christmas. Explaining that as their gift has been a great money conversation starter particularly with my niece who is seven years old.
Even saving a little can help your child feel comfortable pursuing higher education. According to a study, a child with at least $500 saved for college is 5x as likely to go to college and 4x as likely to graduate.
I did a post on Instagram talking about the basics of setting up 529 college savings accounts for your children or children of family members. In today’s post, I’m gonna talk about them in a little more detail as a jumping-off point of your research and whether or not you should set one up.
What is a 529 college savings account?
A 529 account, or 529 plan, is a college savings accounts that offers certain tax advantages and financial aid benefits. In 2017, it was expanded to cover costs for K-12 education, and in 2019 the cover also included apprenticeship programs.
Each state’s 529 plans differ slightly, so make sure to do some research depending on where you live. You aren’t limited to investing in your home state’s 529 plan, but doing so may get you better tax breaks, so be sure to check out that plan first.
Types of 529 savings accounts
There are two basic types of 529 plans:
Savings plans are the most common 529 plan. The account holder (you) contributes money to the plan, which is typically invested in a selection of stocks and mutual funds. You can choose the funds you want to invest in, and depending on how well those stocks and funds perform will determine how much money grows in your account over time.
Tax-free withdrawals from a 529 savings plan can be used on expenses for college, K-12 education expenses, and registered apprenticeship programs. Qualified expenses include tuition, fees, room and board, and up to $10,000 in student loan debt repayment for both account beneficiaries and their siblings.
Prepaid Tuition Plans
Prepaid tuition plans are offered by a small number of states and some higher education institutions (but are not available for K-12 education). They vary in their specifics, but the general principle is that they allow you to lock in tuition at current rates for a student who may not be attending college for years to come (this is beneficial because most institutions raise their tuition every year). Unlike the savings plan, this only covers tuition, and not room and board
Prepaid tuition plans may have other restrictions, such as which particular colleges they may be used for. The money in a savings plan can be used at pretty much any eligible institution.
What if my kid doesn’t want to go to college, or they get a scholarship?
You have a few different options. You can hold on to the account in case they change their mind and go to college later down the line. Or, if they get scholarships and funding for their undergraduate degree, but also want to go on to graduate school after, the money can be withdrawn to be used for that.
If your kid is sure that they don’t want to go to college, you can change the beneficiary on the account to another relative, like a sibling (adoptive, foster and step-siblings count), niece, nephew, son- or daughter-in-law, or even a first cousin. Or, you can even invest it in yourself and furthering your own education.
If worse comes to worst and all avenues have been explored, you can still cash in the account, pay the taxes on it, and the penalties associated (usually around 10%).
What if I don’t have any kids but my siblings can’t get their shit together to open up a 529 account so I can contribute for my niece and nephew?
Great news! You can open up a 529 account for your niece and nephew on your own where you are the custodian of the account. All you have to do is have the child’s social security number. Whats even more interesting is you can start saving for them before they are born. A friend of mine opened up an account for her niece before she was born by opening up an account under her sister’s name and as soon as her niece was born she transferred the account to her niece’s name.
There is also an interesting loop hole to this. The fact that this type of account is not owned by the parents means the money does not have to be reported on the kid’s FASFA paperwork which makes it easier for them to still get financial aid. This loophole may be closed at some point but until then it can be super helpful with the high cost of education.
Other options besides 529 plans
An alternative option is a UGMA (Uniform Gifts to Minors Act) account. If you are nervous about putting money into a 529 account and have your child decide not to go to college this plan allows your child to use this money however they want.
The thing to note though is that this account doesn’t have any of the tax advantages that a 529 account does. With a 529 account your child will not have to pay taxes when pulling the money out for school but with this account no matter what they use the money for (even if they decide after all to go to college) they will have to pay taxes when pulling the money out. 529 accounts also sometimes allow for tax deductions and this type of account does not.
On top of all of that, if your child does decide they want to further their education, according to investopedia a UGMA account “can also have a negative impact on financial aid eligibility. Because they are considered assets belonging to the child, up to 20% of their balance is counted in computing… on the FAFSA. By contract, 529 accounts are considered parental assests, and only up to 5.64% of their balance is counted.”
Still, putting money for your child in a UGMA account is better than having money in a savings account for them because that money can be invested, giving it a chance to grow at a higher rate and if your child doesn’t decide to go to college not having the pay the penalties for using the money for other purposes is a huge plus.
Another option that allows you to invest for a child that gives you the tax advantages and can be used for anything is a Roth IRA account but you can only contribute wages that a kid earns to that account. Apparently though money from babysitting counts (although I don’t know how you verify this lol). You can learn more having a Roth IRA for your kid HERE.
Other things to consider about 529 plans
With a 529 savings plan, your money will have more time to grow and compound, so the earlier you start one up, the better – just like with regular investing. And if you opt for a prepaid tuition plan, you’ll likely be able to lock in a lower tuition rate, since many schools raise their prices every year.
Most 529 plans are pretty low maintenance, allowing you to ‘set it and forget it’ with automatic investments that link to your bank account or payroll deduction plans. And you as the donor have complete control of the account, unless you choose to transfer it to someone else.
Many 529 plans offer gifting platforms that allow friends and family to contribute electronically for birthdays, holidays, graduations, and other occasions. This is great because the onus doesn’t always have to be on you to save towards your kid’s education, plus it gives your family other gifting ideas, rather than buying more material things for your children (such as toys that will eventually break or be forgotten about).
529 plans really do open up a world of possibilities for you and your family, so definitely consider one if your kids, or anyone else in your family, is considering further education. I’d also recommend checking out SavingforCollege.com, which has everything you need to know in much more detail, right down to the state.