the 501k plan book review
Proven investing through financing research. Detailed step by step tutorials in every aspect of retirement investing. Like having a living active life insurance policy that you are able to use as your own personal banking account. This will replace Social Security eventually.
A 529 is an educational savings plan operated by a state to help families save money for college expenses. Before digging into the pros and cons of a 529, I knew very little about this type of savings plan. My ultimate goal is to provide a reasonable sum of money for my children when they go to college because I do not want to burden them with the significant (>$80k) amount of student debt I had to pay off. In this post, I will discuss:
Current college costs and how much you would need to save to cover these cost
Eligible expenses the 529 savings plan covers
The tax advantages for saving into a 529 and other advantages of the 529
What happens if the beneficiary I designate doesn’t go to college?
The steps to set up a 529 savings plan
How much money do I need to save?
I do not know how much college will cost when my kids go to school. I looked at a few different websites and at a few colleges here in Minnesota to get an estimate. Currently, the University of Minnesota costs almost $26k per year for an in-state resident ($36k for out-of-state). Saint Cloud State is around $17k per year ($25k for out-of-state residents). The average cost for public universities across the U.S. is similar, coming in between $20k-$25k for an in-state resident and around $35k for an out-of-state resident. Private colleges are significantly more expensive – average cost around $45k per year.
For my wife and I, we are planning to start saving with an initial $1,000 investment and saving $100/month. There are many investment calculators out there, but as an engineer, I like to do the calculations myself (using excel or google sheets!). Below, I used the future value function (FV) to project what we could save over 18 years with the following: an initial $1000 investment, $100 a month contribution, and a 5% and 7% annual rate of return for comparison.
FV – 5% return FV – 7% return
Future Value $37,375.21 Future Value $46,584.64
Rate 0.4167% Rate 0.5833%
nPer 216 nPer 216
PMT -100 PMT -100
PV -1000 PV -1000
This is a great way to save money. Over the 18 year period, we will have contributed $22,600. Even with a modest 5% return, we will have almost doubled the amount of money we contributed to the 529. The best thing about the gains is that they are tax-free! Now I understand this doesn’t cover the entire cost of a four-year college, which would cost around $100k. However, this is an amount that we are comfortable saving (for now). If we did want to save $100k, I used the payment function in excel to calculate what the monthly contribution would need to be (please email me if you have any questions on the math):
Estimated Payment – 5% return Estimated Payment – 7% return
Monthly Payment ($279.34) Monthly Payment ($224.01)
Rate 0.42% Rate 0.58%
nPer 216 nPer 216
PV -1000 PV -1000
FV 100000 FV 100000
What expenses can the money from a 529 be used for?
Each state specifies what the money can be used for. Check this website to ensure what the plan for your state covers. The money can be used at any accredited university, college, or vocational school. Per the Minnesota Disclosure booklet:
“Qualified Higher Education Expenses are defined generally to include tuition, certain room and board expenses, fees, the cost of computers, hardware, certain software, and internet access and related services, and the cost of books, supplies and equipment required for the enrollment or attendance of a Beneficiary at an Eligible Educational Institution. On page 18 of the Disclosure Booklet, under the subheading “Qualified Withdrawals,” the following sentence is added to the end of the second paragraph: To be treated as Qualified Higher Education Expenses, computers, hardware, software, and internet access and related services must be used primarily by the Beneficiary while enrolled at an Eligible Educational Institution. Qualified Higher Education Expenses do not include expenses for computer software designed for sports, games or hobbies unless the software is predominantly educational in nature.”
What are the tax advantages?
When considering the tax benefits of the 529 plan, you need to look at the federal and state tax implications. Each state’s tax benefits are different. Here is a good website that enables you to compare different state’s plans and their benefits. You can, for almost any state, set up your 529 in a different state. For example, Utah’s plan has performed the best over the last 10 year period. Additionally, I will discuss estate planning tax benefits.
Federal and State Tax Benefits
The Federal and State tax benefits are similar. The money that is invested into a 529 plan is NOT deductible on taxes. However, any gains made over the course of the investment are not taxed. Finally, there are no taxes paid on the money you withdrawal as long as the money is used for college expenses.
Estate Tax Planning Benefits
There are ways to utilize the gift tax to further enhance the 529 savings plan. A single filer can contribute $14,000 per year and married filers can contribute $28,000 per year -there is no federal gift tax on these contributions if they are under these amounts [1].
Other advantages of a 529 savings plan:
Favorable financial aid treatment: only a maximum of 5.64% of the value of parental assets are counted toward a student’s Expected Family Contribution, compared to 20% of the value of the student’s asset [2].
The 529 savings plan has low fees [2]. Below is the current fees for the MN plan:
529 MN Fees
http://www.savingforcollege.com/529_plan_details/index.php?page=plan_details&plan_id=28
There are many investment options, including age-based portfolios that automatically adjust the level of risk (e.g. lower risk as beneficiary gets older).
Anyone can contribute to the account: grandparents, other family members, and friends.
What if my beneficiary doesn’t want to go to college?
Once you open an account, you can change the beneficiary. Eligible people include family members of the original beneficiary: immediate family, grandparents, stepchildren, in-laws, first cousins, etc.
Three simple steps to set up a 529 savings plan:
Here are the steps I followed to set up a 529 savings plan in Minnesota – it is quite simple. In addition, I looked at the process to open an account in Utah and New York and the process is similar (and simple too!). If you need help determining how to set one up in your set, please contact me or leave a comment:
For Minnesota, download the application here
Designate a beneficiary
Select your investment options
Here are the sources I used to support my research for this post:
the 501k plan book review by Tom and Mark Ford Dyson
Proven investing through financing research. Detailed step by step tutorials in every aspect of retirement investing. Like having a living active life insurance policy that you are able to use as your own personal banking account. This will replace Social Security eventually.
