My wife and I are both grad students, currently without any children. Even so, I recently opened 529 plans through Learning Quest (Kansas). What is a 529 plan? Essentially, it is a tax-advantaged account meant for future expenses related to higher education.
I’m embarrassed to admit that I thought you could only open 529 plans after you had a child. I was wrong, so here are five reasons why you should open a 529 account right now if you don’t already have one:
1. You don’t need kids to open a 529 account. In fact, you can open an account for yourself, for your spouse, or for whomever you please. With a few clicks, you can change the beneficiary at any time.
My wife and I opened accounts for ourselves even though we’re both nearing the end of our terminal degrees. Essentially, I plan to “launder” money through the 529 accounts – I’ll dump in some cash, let it grow tax free, and then use it for the remaining education expenses that we have. Whatever is left in the accounts will begin compounding away for any children we might have in the future. Yes, I’m kicking myself that I didn’t start doing this sooner!
2. Money grows tax deferred at both the Federal and State levels while in the account. Provided that you use the withdrawals for qualified education expenses, the earnings are also tax free. So, what are qualified distributions? Many things, including tuition, campus fees, meal plans, room and board, books, and other required equipment. Provided you can prove that it somehow relates to education, most anything goes. Yes, a laptop computer counts. No, a semester’s supply of iced mocha lattes probably does not!
3. You may be able to claim a state income tax deduction. Some states allow you to claim contributions as income deductions. For instance, the Kansas plan that I use allows me to claim an annual adjusted gross income deduction of up to $3,000 ($6,000 if married, filing jointly) for contributions per beneficiary, per year.
So, not only do I get an upfront state tax break, provided I use the money for qualified education expenses, the earnings are tax free. It’s the best of both worlds.
4. YOU remain in control of the account, no matter the name and age of the beneficiary. Money that you contribute to the account remains YOUR money until you decide what to do with it. If the named beneficiary decides to drop out or skip college entirely, he or she cannot access the funds. The money is then yours to do as you will. Pay the tax penalty and withdraw it all, or simply change the beneficiary to another family member without penalty. Also, all funds in a 529 are sheltered from bankruptcy (in case you run into financial hardship later).
5. Low minimums, high maximums, and low expense ratios (provided you shop around). Depending on the plan, you probably won’t have to commit much money to start the account. The Kansas plan that I chose only has a $250 minimum (Kansas residents only; $1000 for outside residents), or you can open the fund with an automatic monthly contribution of $50 ($25 for Kansas residents).
Keep in mind that you do NOT have to settle for the 529 plan offered by your state. You can open or contribute to any 529 account, no matter the host state, though you may not be able to claim a state tax deduction if you do so. As a Kansas resident, I can invest in any state-sponsored 529 plan and still claim a Kansas tax deduction – be sure to investigate how your own state operates. However, if your state’s plan does not offer a tax deduction at all, please shop around to find a plan with funds and expense ratios that suit you. Speaking of which….
I was pleased to see that the Kansas 529 offering includes Vanguard funds. It’s no secret that I’m a fan of both Vanguard and Index funds, so in my case I opted for the Total Bond Market Index Portfolio, which has a total expense ratio of 0.25%. Unbelievably, this is an even-lower expense ratio than if I were to invest in the same fund from within the Vanguard 529 Portfolio itself (expense ratio – 0.55%)! In any case, be sure to consider the expense ratio (and any other fees) for any funds in your 529 account. Lower is better. The Kansas plan has no fees other than the expense ratio. If your state’s plan has hefty expense ratios plus annual fees, RUN!
Also, the maximum contribution limit for 529 accounts is quite high, usually around $300,000 per beneficiary. As a poor grad student, I can’t imagine having that much money right now, but it’s nice to know that the sky is practically the limit.
One last thing that I want to add: while I think 529 plans are great, I suggest maxing out your IRA before contributing to a 529. In other words, a student can always apply for scholarships and financial aid, but there are no scholarships available for retirement!
The Essential 529 Guide – http://www.savingforcollege.com
529 Plans – Wikipedia link