As all of us learn to calibrate a “new normal” in the COVID-19 world, we can find glimmers of hope and joy in the happy events still happening around us. Babies are still being born, for example. Despite shifting to Zoom baby showers and making grandparent introductions by Facetime, today’s new parents need to focus as much as ever on the core financial needs of raising a child.
Unless you have a trust fund or ample cash reserves to self-insure against catastrophe, your first step should be putting in place emergency coverage for your little one’s first 18 years. A term life insurance policy is a relatively low expense but yields peace of mind that living expenses for your child can be covered in the event you or your partner dies. With that step done, it’s time to tackle a plan for funding his or her education.
You’ve probably at least heard of a 529 plan, which is a savings plan that can be used for qualified education expenses. What you may not know is that a 529 plan now can be used to cover up to $10,000 per student, per year of tuition at private primary and secondary schools, an incentive to take action by funding a 529 plan sooner than later to benefit from years of tax-free growth.
For students attending a college or a university, 529 plans can cover qualified expenses such as tuition and fees, room and board, plus computers and even student loan repayment in some cases.
When it comes to choosing a 529 plan, it may seem as though there are a lot of things to consider, but don’t let analysis paralysis get in the way. Here are three things to know about 529 plans and how to get your money working for your child’s future now, so you’re set to benefit when the market rebounds.
Simply Put: Plenty of Room to Grow
Like Roth IRAs, 529 plans are funded using post-tax money, which means that no taxes are due on the funds when the account holder takes money out of the account. But unlike Roth IRA contributions, there’s almost no limit* to how much you can contribute to 529 plans. Your 529 plan contributions grow tax-deferred and you’re not forced to take money out of it – ever. Having so much freedom to make contributions is especially helpful since anyone – grandparents, extended family, friends – can contribute to the account to encourage your child’s future educational pursuits.
Never Lose Possession of your Money
In the old days, parents and grandparents would open a custodial account in an effort to ensure their loved one’s long-term financial success. This proved to be a risky move in many cases as the funds set aside for the child became theirs at age 18, and the money could be at risk of quickly being squandered away. When you fund a 529 plan, you remain the owner of the fund and never lose possession of your money. You control what goes in and out of the fund, and benefit from the peace of mind that comes with knowing there’s an extra level of protection for your long-term financial planning efforts.
Take Advantage of Tax Breaks
All 50 states have or sponsor at least one type of 529 plan, and many states offer tax and financial benefits when you fund it. Regardless of which state you live in, money in a 529 plan grows tax-deferred and will not be taxed when the money is taken out and used for education. One point to note: while there is no limit to how much you can contribute to a 529 plan, most states limit contributions that qualify for state income tax deduction or credit. It is worth a conversation with one of our Wealth Accumulation Advisors to discuss the nuances of 529 plans in your state prior to selecting one for your family.
But What If….
The micro-generation of COVID babies being born right now probably faces more uncertainly about what future education and work opportunities look like than any other generation in history. On top of already shifting professional trends and higher education funding structures (read mounting student debt levels), it’s impossible to predict what path your child may take in 18 years.
But there’s no need to worry about overfunding a 529 plan or that it will be “wasted” if your son or daughter doesn’t pursue a traditional higher education path. In the case that 529 funds are not used for education, you only pay taxes on the fund’s earnings in addition to a 10 percent penalty on those earnings. Given the years of tax-deferred growth offered by this instrument, it’s likely your little one will still come out well ahead financially thanks to your diligent planning – whether he starts his own business or she becomes the next Nobel Prize-winning PhD.
Questions about starting or funding a 529 plan? MAP Wealth Accumulation Advisors are here to help you navigate this important next step in your family’s financial planning. Get in touch with us to talk next steps on your journey to building financial security.
*While there are limits on how much can be contributed to a 529 plan (and these limits vary state by state), they are extremely high. The average family is typically very far from reaching the contribution limit. Every state’s 529 plan allows for maximum contributions of at least $235,000 per beneficiary, with some states allowing more than $500,000. Contributions made past these upper limits will be rejected and returned to the investor.