Run, don't walk, from 529 Plans

In the mid 1990s, the government realized there was a huge issue between
the rising costs of education and Americans not saving up for it ahead of
time. A solution to help curb this problem was invented by having a
specific savings account with tax benefits for higher education costs. The
brainchild was known as a 529 plan.

So what is a 529 plan? Well, it’s basically a “savings” account to be
spent on higher education costs. This savings plan is beefed up by
allowing interest to grow in the account tax-free when it’s earned and
when it’s used (as set by the plan). Here are some specific benefits and
limitations:

? No limits on how much can be put into the account. This is great for
people who can afford to put large amounts of money in and also people who
receive lump sum payments such as inheritance, settlements or for
taxpayers who earn too much money to have a Roth IRA (There are gift tax
issues on amounts more than $14,000 that I won’t get into here).

? You don’t have to pay tax on the interest!
Have you heard the inquiry “Would you rather pay taxes on the seed
(principle) or the harvest (interest and principle)?” Well, with a 529
plan, you pay tax on the seed, so the harvest comes out tax-free, meaning
you put money into the account on which you’ve paid taxes, but the money
coming out of the account with interest is then not taxed.

? You can own a 529 plan and have it be for a different beneficiary than
yourself. This is particularly important for family members saving for
college — that makes it perfect for parents and grandparents to start
accounts for their loved ones and increase the likelihood of going to
college. The donor also retains control of funds. Donors can even reclaim
the funds for themselves but are subject to a 10 percent penalty on any
earnings. There is an option to transfer the beneficiary to another family
member if the original one cannot go or chooses not to go to higher
education.

? The account can be used for tuition, books and supplies as well as room
and board. If the beneficiary lives off-campus, the amount taken for room
and board is capped at the equivalent cost of that person living on
campus. The bill passed by the house will also add “technology expenses”
such as computers and equipment that may be required by the institution.

So why might you want to run from a 529 plan? For me it’s a simple issue:
there is little flexibility or control without facing penalties for a
long-term savings strategy. Any kind of savings plan is a good idea just
on the basis of it being a savings plan, but your money deserves the best
treatment. For college savings, you should be looking into a
steroid-induced plan that gives you power, positive tax treatment, control
and flexibility.

Any kind of savings plan is a good idea just on the basis of it being a savings plan, but your money deserves the best treatment.

For me, that plan is typically in the form of a Roth IRA. It’s designed
similar to a 529 in which you pay tax on the seed (principle) going in and
the harvest (interest & principle) comes out tax free. Why is a Roth IRA
so much better? Here are some benefits:

? The most basic reason for a Roth IRA is for retirement. You can put
money into a Roth IRA at any time and don’t have to take a required
minimum distribution. If you continue working after age 70 1/2 and want to
continue contributing to your plan — you can! The annual limit is set high
at $5,500, so as long as your income is within restrictions (they are
high, as someone married filing jointly has to be less that $181,000,
single/HOH $114,000)

? You can use money from a Roth IRA for first time homebuyer expenses, up
to $10,000.

? You can pull out money before retirement age if you become disabled.

? You can pull out money for higher education costs for yourself or any of
your family members. This even includes grandparents pulling out money for
grandchildren! The uses for the money are similar to a 529 plan.

? Roth IRAs have the same benefits as a 529 plan but go above and beyond.
The proof?
There aren’t plans with significant amounts in them.
Steve Rosen with The Kansas City Star reported the average size for a 529
account is $20,474, according to the College Savings Plans Network.
As Rosen notes, “That’s about what it costs to attend many public in-state
universities for one year”1

The 529 plans fail to take into account life circumstances and answer the
needs of such.
What do I do with the money if the beneficiary doesn’t go to school?
What if the beneficiary is now estranged?
What if the beneficiary doesn’t use all of the funds?
I would hate to see someone have to pull out money and pay a penalty on
these funds in answer to these questions. With the flexibility of the
Roth, if for some reason the funds won’t be used for education, they will
still be set up for a retirement account without any diversion of funds or
the risk of a penalty.

Let’s start a conversation. Please comment below with your thoughts. Do
you have a 529 plan? What is your opinion on these plans?

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Financial Guru, Pilot, Volunteer Firefighter, Eagle Scout and still holding out to go to space someday.

Tax Code and Financial Products run my life. I believe financial education is the key to progress in our society. Do you agree? Comment and let's start a conversation.