Just having a 529 plan for your child or grandchild might not be good enough.
The advantages of saving in a 529 plan are well-known insofar any investment gains would not be taxable when withdrawn for qualified expenses. In Pennsylvania, deposits to a 529 plan are tax-deductible for Pennsylvania income tax purposes up to $15,000 per year per child.
Another way to fund college is to use a pre-paid tuition plan. Pre-paid tuition plans, like Pennsylvania’s
Guaranteed Savings Plan, will pay for a course or a semester at a level (like community college or private college) selected by the investor. Money can be used at almost any college – even a more expensive one — with the student paying the difference if they want to go to a school that is more expensive. The problem is that the state has promised certain payments, which they may or may not be able to meet. College tuition sometimes increases much more than inflation. What investment will plan administrators use that will perform that way? To make up the shortfall, they have begun to add fees and charges. This is similar to the problem with defined-benefit plans like pensions, which may or may not have enough money to pay the benefit. At least most defined-benefit plans have Pension Benefit Insurance Corp. Insurance, but the pre-paid tuition account in Pennsylvania has no such insurance. The fine print says it clearly:
“Accounts guaranteed only by GSP…are not insured or guaranteed by the Commonwealth of
The prepaid tuition accounts also hurt more when calculating financial aid than other college savings plans. These other plans are usually owned by the parents or grandparents and do not carry nearly the penalty for financial aid purposes. Because they are not guaranteed, it might not be a good idea to use GSPs, especially families who expect to apply for need-based financial aid.
The 529 option uses mutual funds and does not promise a particular tuition payment. Pennsylvania allows its residents to invest in any state’s plan and gives the investor the tax deduction nonetheless.
But the real problem with all of these plans is that people are not saving enough for college. If a family saves a modest amount of money in any of these plans that will be helpful but is likely to be insufficient. (Many clients deposit $50 or $100 per month.) The results from this underinvesting are the excessive amounts of student loan debt. Student loan debt in the United States has passed $1.75 trillion dollars. This is more than all of the credit card debt outstanding. We are seeing people half-way through their working lives still paying off their student loan debt. Unlike hospital debt or credit card debt, student loans cannot be forgiven in a bankruptcy. We come across investors who have over $200,000 in student loan debt.
One solution to the problem of leaving your children or grandchildren with a lifetime of debt is to save more in their 529 college savings plans now. Many investors are doing this. They are dealing with stock market risk by using accounts that start out aggressively but use less and less stocks as they get closer to college. Many parents are worried about the penalties for tying up the money if the child does not go to college, but we explain to them that there are many satisfactory options for using the money for different students in the family or even for the next generation. The fact that all of the earnings of a 529s are tax-free when the money is used for qualified college expenses makes 529s a winner.
Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. With other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover education costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. The tax implications can vary significantly from state to state. Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer’s official statement and should be read carefully before investing. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan. Any opinions are those of the author and not necessarily those of Raymond James. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation.