When flight attendants prepare passengers for a flight, they almost always say: “In the event of an emergency, secure your own oxygen mask before assisting other passengers.” There’s a good reason for that: If oxygen gets too low, a passenger risks becoming incapacitated and being physically unable to help others, including their children or grandchildren.
Financial planning for a college education works in a similar way. While you may want to pay for your child(ren)’s college, it’s important not to jeopardize your own financial plan in the process. In other words, parents and grandparents should put their own oxygen mask on first (prioritize their retirement savings) before assisting others (paying for college).
Luckily, there are a number of tools to help you do just that, starting with 529 college savings plans. Before we dive into the details, let’s look at what college might cost when your child is ready to attend. We’ll also cover some alternatives to 529s for those who qualify.
What will college cost in the future?
It’s no secret that colleges have become increasingly more expensive to attend, and there’s no indication that this trend is changing anytime soon.
That number is set to rise. It also doesn’t account for added expenses like room and board, travel, or books and equipment. Depending on what school your child attends, it’s likely that they’ll be spending upwards of $100,000 or more on college-related expenses. Using a 7.3% annual rate of inflation and current college costs, here’s what you can expect college will cost in five, 10, and 15 years.
What is a 529 Plan?
A 529 plan is a state-run savings plan designed to help cover educational expenses. Initially, this was specific to costs tied to college or universities, however the program’s reach is steadily expanding. Now, the “qualified educational expenses” covered by 529 plans include K-12 tuition, trade schools, and more.
Every state offers its own 529 plans, except Wyoming, which uses Colorado’s plan. You don’t have to use your state’s plan, but there may be tax incentives to do so.
When researching plans, it’s a good idea to start with your state’s options, and your financial advisor can help you evaluate your choices. Many states offer two types of plans: One intended for financial professionals, and another intended for parents and family. Be sure you’re looking at the latter as you do your research.
At Revo, we don’t directly handle client investments in 529 plans. We prefer to take an advice-only approach, helping clients choose a plan that makes sense, select investments, and fund the accounts as part of a broader financial plan.
While 529 plans offer tax advantages, these advantages often vary by location and circumstance, so we’ll look at everything from tax treatment to past performance and fees as we review potential 529 plans.
Savingforcollege.com keeps an up-to-date list of 529 account fees and performance by state.
Traditional vs. custodial 529 plans
There are two primary types of 529 plans: traditional and custodial. While the plans function the same at first, the structure can matter a great deal when it comes time to fill out the Free Application for Federal Student Aid (FAFSA).
A 529 plan is structured to have an account owner and a beneficiary. With a traditional plan, the account owner maintains control, meaning it’s possible to change the beneficiary if your child decides not to go to college or withdraw funds (subject to penalty) in a pinch. However, if you own the account, even if it benefits one of your children specifically, it may be considered in the financial aid application for your other children, too.
In a custodial 529 plan, the beneficiary gains control of the account when they reach legal age, and the funds would account on that child’s FAFSA only. However if you, as the custodian, needed to access funds in an emergency, you wouldn’t be able to pull from a custodial 529 since you are technically the custodian only, and not the account owner.
Another thing to consider? 529 accounts owned by grandparents (versus parents) aren’t currently counted on the FAFSA, though they usually are on the College Scholarship Service (CSS) profile.
Figuring out how to set up 529 accounts, including the type of account and owner, is something the Revo Financial team can help with. Whichever type of plan you go with, anyone is allowed to contribute — friends, aunts, uncles, and so on. Plus, there are no firm contribution limits to either type of 529 plan, though the overarching rule is that you can’t contribute more than the anticipated cost of college.
Using 529 Plans
When made on qualified education expenses, withdrawals from 529 plans are tax-free. If you withdraw the funds to use on non-qualified expenses, they may be subject to a 10% penalty and capital gains tax.
As we mentioned earlier, the government is slowly increasing what qualifies as an educational expense. Different types of post-secondary education now make the cut, as do expenses like computers and even room and board on occasion. Some funds (up to $10,000) may even be used for K-12 education. On top of that, any leftover funds in a 529 can be used to help pay down student loan debt.
The most recent change to how 529s can be used came in late 2022 when Congress passed the SECURE 2.0 Act. Starting in 2024, plan beneficiaries can roll up to $35,000 from a 529 plan into a Roth IRA. The account must have been opened for at least 15 years, and the beneficiary needs to be eligible to contribute to a Roth IRA (which does have income limits). Additional requirements may apply, which we can help you review if this is an option you’d like to pursue.
Other options beyond 529s
While 529s are the most popular option for college planning, they’re still a somewhat new tool, and they are far from the only product to help parents save for college. For instance, custodial accounts under the Uniform Transfer to Minors Act (UTMA) or Uniform Gift to Minors Act (UGMA) may also be an option. These accounts don’t have as many perks as 529 from a tax perspective, so they aren’t as common when it comes to college planning.
Other tools, including those not designed specifically for education, may be useful as well. For instance, indexed universal life insurance policies (IUL) can be used as part of a college savings strategy. Not every family will qualify for this type of policy, and they are complex, so we recommend working closely with a professional, such as the Revo team, to ensure you understand how the policies work and are taking full advantage of what they have to offer. For instance, IUL funds might help your child put a down payment on a home if they decide college isn’t for them.
The takeaway here is that you have multiple products to help create a college savings strategy that makes the most sense for your families. An IUL policy may not be right for everyone, just like a 529 plan may not be the best choice for you.
College planning is always done best when it’s part of a broader, comprehensive financial plan that takes your retirement and other family priorities into account. If you have questions, we’re always happy to discuss.
