I do not have 529 accounts for my kids. There I said it. The reason we do not is not because we cannot afford it. I’ve stated we are on track to save 1 year’s worth of expenses in 2017. It’s also not because I do not plan to pay for my children’s college. It’s not even because I do not think it is a good deal to pay for college. So why don’t I contribute to a 529?
What is a 529?
A 529 Plan is a tax advantaged college savings plan. You place after tax money into the account and any earnings on the funds accrue tax free so long as they are used them for college expenses. College expenses includes the cost of community colleges, universities, post secondary, or vocational schools. It can also be used for items needed to support that education like computers. This makes them the tax advantaged equivalent of a 401K or Roth IRA. However, they come with a catch. They need to be used for education.
This requirement to use it for education is actually fairly flexible. It can be used for the person you set it aside for, or you can apply it to another family member who may attend college. Even if your kids skip school, you could use it for a grandchild. You can also use it to pay for continuing education for yourself. The point is that it must be used for education or you will pay a 10% penalty plus income tax on earnings to remove the funds.
529 College Education Exceptions
There are a few decent exceptions to the rule. If your child earns a scholarship, attends a Military School, becomes disabled, or dies you can avoid the 10% penalty, but you will still be on the hook for the income tax. In the case of scholarship, this exception is limited to the amount of the scholarship.
Plans are typically provided by states. In most states you will receive special tax treatment only on your own state’s plan. As such it makes the most sense to invest in your own state’s 529. However, there are some exceptions so you should check your state’s rules. Also there are no income limits on contributing to a 529, so anyone can do it.
Why do I still not contribute?
The above sounds like a sweet deal, and in some scenarios it is. However, I have decided it is not for my family for the following reasons:
- Fees of 529s are higher than their mutual fund equivalents. The difference is not huge, you’re talking perhaps in the neighborhood of .25 percent. That’s not a huge difference. Over about 18 years this will cost you about 460 dollars on a 10,000 dollar investment. Still it is a difference.
- Typically, you can’t choose your investments. They are chosen for you by the 529 Plan as something akin to a target date fund. I have stated before I am not a fan of target date funds for lack of control of the investment. The same applies here.
- Furthermore, many of these plans shift assets around various funds automatically over time to be more conservative as you get closer to usage. This may not be in line with the allocation of our overall portfolio, and I’m not entirely comfortable with part of our portfolio being out of sync. This would likely result in a lower return for this portion of my portfolio.
Money is fungible so there is no structural difference between paying for college out of my 529, my savings, or my paycheck beyond the tax benefits, the 529 costs, and the 529 rate of return. So if costs are higher as per my first point and rate of return is lower per my third point, then the tax benefits need to make up the difference.
My view on 529 Tax Benefits
So, about those tax benefits. They are pretty sweet and there are a lot of loopholes. However, I can not shake the feeling that I may need one of those loopholes. I’ve stated before I believe the costs of college will see a massive decrease in our lifetimes. I also like to think my kids will get some sort of scholarship. It is very difficult to estimate the amount I’d need in these accounts. Go above and I face a wipe out of any tax benefits. Remember there is no exception to the income tax benefits if not used for education, only the 10% penalty. So the 529 is not without risk.
Meanwhile, there is the risk that the laws will change and the tax benefit will disappear altogether. That balloon was floated in discussion in 2015 by the national government. It was roundly rejected by the public, but any investment in a 529 is essentially placing a bet on those tax benefits remaining. That makes me nervous.
Tax Advantaged Opportunities are Abundant
The final reason for me speaks to the volume of taxable accounts otherwise available. Think about it, as a worker you might qualify for a 401k of 18K/yr. You also could qualify for a Roth IRA of 5.5K/yr. Your spouse gets the same thing if he/she works (as mine had previously). You have HSAs which are 6.75K per household. Right there you’re talking about the median family income, 53K, in the US. You can add to that other tax advantaged options like Flexible spending accounts for day care (5K, but only on initial income), Employee Stock Purchase Plans (10% of pay limits, deferral of tax only), I and EE bonds are tax free when used for education (10K per year), municpal bonds are typically tax free, and mortgage payments. If you’re self employed you can throw in up to 53K on top of that in employer contributions provided your company makes enough money. The point is you can really sock away a large number in tax advantaged accounts without incurring the lower return risks of a 529. Simply put it is better to prioritize accounts with more flexibility like a Roth IRA or a 401K over an account with spending limitations like a 529. You should also be prioritizing your own retirement over your children’s education anyway. It will not help anyone if you pay for their college and then 5 years later you move in with them because you’re broke. So those accounts become first and there are just so many options available there I do not see the need for a 529 in my life.
Infinite Money and a 529 College Savings Account
A final note, with infinite money I probably would get a 529. Furthermore, if my income were too high for many other tax advantaged accounts my decision might be different. I’d consider taking the risk of tax laws changing with the understanding that should my children not need it I could have my children inherit it and use it for their children. In the real world, to date it just does not meet our needs. Maybe that will change some day.