Changes to the Rules of 529 Plans Shouldn’t Change How Smart Investors Use Them.
With the back to school season upon us, I’m reminded again of the expenses of educating children and grandchildren - the cost of one year at Villanova this year is just under the cost of my entire education there from 1990 to 1994. No wonder families are struggling to build enough wealth for both college and retirement.
If you ask a financial advisor how to save money for college, they will usually suggest using a 529 Plan. There are many benefits of these plans, including tax-free growth, control of the asset (meaning the beneficiary never gets to choose how the money is used – the owner does), and a reduction in estate tax exposure. I wrote a blog last year about how to maximize the efficiency of a 529 plan, and I believe that an additional component to the success of 529 plans is that they are so widely accepted as the tool to use to fund college education. Want to invest to save money for college expenses? Open a 529 plan.
While 529 plans were nearly perfect in their unique features and widespread use, Congress recently decided to make them more complex (as Congress likes to do). When the Tax Cuts and Jobs Act of 2017 was passed in December, one of the provisions made the funds in 529 plans available for pre-college education expenses. Essentially, you can now dip into your 529 plan to pay for private schooling prior to college. While this may seem like simply another option, it ignores the time-tested benefit of investing - compound interest, which basically allows for your money to continue earning alongside your original investment. The longer your money is invested, generally the more money your money can make.
I encourage families who are saving for college to do it as early as they can to allow time to build the college nest egg for them, so they don’t have to contribute as much money over their lifetime as they would if they started later. The corollary recommendation is not to depend on these accounts for pre-college expenses, as you shorten the time that the funds can grow.
Why? We can use the Rule of 72, which tells us how long it takes for your money to double given a certain rate of return. To make my scenario easy (and perfect), let’s assume an 8% rate of return. Divide 8 into 72, and we find out that it takes approximately 9 years for your money to double. If you invest $10,000 when Susie is born, you will have $20,000 when Susie is 9. Sure, you can use that for a year of private school. Or you can leave that money in the 529 Plan for 9 more years and have $40,000 to use for college.
Just like all investments, 529 plans are suitable for many investors who want to save for college, but may not be suitable for all investors who want to save for college. If you need help saving for college, talk to your financial advisor or your CPA, or call us. We’re here for you.
Investors should consider the investment objectives, risks, charges, and expenses associated with 529 plans. This information is outlined in each issuer’s official statement, which should be read carefully before investing. The tax rules that apply to college investing options are complicated. Consult with your tax advisor about the tax consequences of investing in college savings, as well as whether your state offers a 529 plan that provides residents with favorable state tax benefits.