Last week’s episode probably got you thinking about saving for education expenses. Starting early can make paying for an Ivy League college for your budding genius a reality. Now that we’ve established the ‘why’ of education savings, this week we talk about the ‘how’ to plan for education expenses. 

The bottom line is to use 529 plans. Sure, you could funnel money into your brokerage accounts and earmark it for education, but then you miss out on the substantial tax benefits that accompany 529 plans (similar to 401K’s and HSA’s). Any contributions you make to a 529 account grow tax-free, meaning that the capital gains interest in dividends you earn from growth is all tax free. Then, when you make withdrawals to spend on qualified education expenses, those are also tax-free. So once you put the money in, it’s all tax free when you use it for qualified education expenses. 

Listen in to hear Matt Robison and I talk all about the in’s and out’s of 529’s. 

  1. Beneficiary Flexibility: 529’s offer the option to change beneficiaries at any time. You can set up an account now for an unborn child, grandchild, niece, nephew, etc. If one beneficiary doesn’t need the funds or use the entire balance of the account, you can switch the account holder to another child or to yourself. 
  2. Multiple Accounts: While 529’s provide flexibility in beneficiaries, you will still want to establish multiple plans for multiple children as they may overlap in spending plus there are contribution limits per beneficiary, per year.
  3. Do Your Homework: Each state offers a different 529 plan with different benefits. Start with your own state and begin by assessing tax deductions. If they aren’t great, look at other states’ plans for things like low cost funds, better investment options, account fees, portfolio management fees, program manager fees, state fees and the fund fees. Spoiler alert: Illinois and Utah have two of my favorite funds.
  4. Set-it-and-forget-it: Invest in low cost index funds or age based index funds during your initial set-up so that all future contributions go directly into that fund. 
  5. Spending from your 529: Sure, you can spend money from the fund on things like tuition and fees, books, computer technology etc. But did you know you can also use it for Kindergarten through high school? Distributions are capped at $10,000 a year, but you can use the account as a pass through for tax deductions (put money in then take it right back out to pay for education). It can also be used for student loan repayment up to $10,000.
  6. Leftovers: There are many ways to spend the money in the 529 but if you find yourself with leftover funds, you can pass that on to related family members, or use it on yourself! Have no one left in your life with qualified education expenses? You can still access that money and use it on non-qualified expenses. You’ll pay a 10% penalty on any of the growth and you’ll have to pay taxes. No one I know has ever complained about extra money leftover.

Hopefully after last week’s episode and this week’s breakdown of 529’s, you are feeling more confident about your education savings plan.

Learn more about Mike and my services at https://www.mortonfinancialadvice.com and connect at https://www.linkedin.com/in/mwsmorton/

Are you ready to create your ideal lifestyle? Let’s Connect.

Transcript
Matt:

Welcome to real financial planning broadcast on WKXL and available wherever you get your podcasts, I’m joined, as always by Mike Morton, the host of financial planning for entrepreneurs, and the proprietor of Morton financial advice. Mike, your podcast is called financial planning for entrepreneurs. But you're not just talking to entrepreneurs.

Mike:

From entrepreneurs, tech professionals, all adults out there kids out there everybody who finds this content useful role entrepreneurial your own life.

Matt:

Yeah, I mean, in our own way, you stand up and you say, I am gonna go out and get a burrito for lunch, or you're taking charge of things, you know, you're being kind of entrepreneurial speaking and taking charge of things. We just finished recording an episode about how and when to start thinking about saving for education costs. I commend that episode to everyone. It's going to be in the financial planning for entrepreneurs podcast feed, and the capital close up podcast feed, check those out. It's just a general high level orientation to the topic of let's say, you're in this situation, you have kids, they're gonna want to get educated, you want them to be educated. You don't just want them to be, you know, part of roving gangs ravaging cities. What do you do? How do you start to think about that as a useful conversation. We got some good stuff out of that, but we promised that we would do a follow up about the main savings vehicle that most people use, although you don't want to overlook that Roth IRA. So again, check that out. That's a really useful hidden trick. But the major one that people use, is the 529 account. And so what we wanted to drill down on in this episode is just a real compact news. You can use everything you need to know about 529’s, how to set them up, what to do with them, how to think about them. Here we go. And Mike, what's a 529? Why is it called 529?

Mike:

I think it's the I was just thinking about that, as you were talking there. I think the 529 is from the IRS code. I think that's why it's called a fun section of the IRS Code. That's why we call them 529’s education savings.

Matt:

The fact that they're 529, exactly, you gotta have to you have to wait to find 20 others…

Mike:There's probably a couple of:Matt:

Well, that's a career that I'm glad I didn't pick.

Mike:

Oh, my goodness, yeah, that'd be fun. Or you can do the IRS code. So section 529. And these are accounts that are earmarked for education costs, so you can use them, you can put money into an account. These are account types, you're used to savings account, checking account, what we call brokerage account, where you can invest in stocks and bonds, you got 401k’s and IRA’s and all kinds of stuff. So this is another one. And yes, you have to set up a new one. And it is a 529 account. And then you put money into it. And you can invest that money. And hopefully it gets grows over time. And then you pull that money out specifically for education costs is why we're saving into the 529.

Matt:

So when you have accounts that you're setting up for young people, and we've actually done two episodes about this, recently, we did an episode where we talked about beginning to save helping young adults, even teenagers, even kids who are younger than that start to save for their retirement turns out that getting going early, massive, massive benefit to doing that. And we also did the last episode about just thinking about education costs in general. So as you approach this, one of the considerations is, you're typically saving for someone who's not quite old enough to own an account for this to be their investment. So how does this work? In the context of a 529? What exactly are you doing to set this up?

Mike:

Yeah, these accounts like your checking or savings account of course you're just the owner. And that's kind of it. So these accounts have a couple of different people involved. There's the account owner, who sets up and does the account. And then there's the account beneficiary who is going to be the beneficiary get the money for their education. So that's typically your child could be a grandchild, niece nephew, it can be anybody you can set up to not account for absolutely anybody. So you could be the owner. And then there's a benefit. So there's there's two parts there in terms of the account.

Matt:

And so if you're a grandparent listening to this, you could set up your own 529 account right now, where you're the owner, your grandchild is the beneficiary, and you could start plunking money into it today.

Mike:

Yeah, in fact, One quirk about these 529 accounts, which we can talk later on, because it's, you know, it's kind of interesting, but not that relevant is you can change the owner at any time. And you can change the beneficiary at any time. And it's a really bizarre thing because think about your checking account, you can't really just change the owner of your checking account to anybody you want. But these 529’s, you can change account ownership. And you can change account beneficiaries. Now the beneficiaries, it makes sense, but it still is kind of bizarre, because they want the flexibility that you could use the money in the account for other beneficiaries. If your child doesn't use it all, you could change it to their sibling, you could change it to a niece or nephew, you could change it to yourself. But this has a lot of implications, because this is where you can start a 529 for an unborn child, because you can be the account owner and the account beneficiary, okay, put in a few $1,000 or whatever. And then you can change the beneficiary to a child that is born two years later.

Matt:

Wow, he said this would be news you could use. But there's two really awesome tips in there. One is, I just never thought about that, that concept that like you got married, you're considering having kids sometime soon. And you were just saying in the last steps, like starting early is great when it comes to any kind of savings. So do it now make yourself the beneficiary change it later. So that's one really practical application of this. The other is, this is an awesome way to have amazing leverage over people in your life, and to have incredible family arguments and retribution. So now especially for you grandparents, were sitting on set set up an account like this for your grandchild today. And then if you disapprove of their life choices, you don't have to go through all the mishegoss of writing them out of your will you just change the beneficiary. It's like, hey, that $100,000 for your college, it's gone. Nope, I don't like that your dating, Sandra. No, no, as soon as you break up with Sandra, I'm changing the beneficiary. This is great.

Mike:

Yeah, they do call the 529 a poor man's trust for exactly that, because it is kind of a trust account for the beneficiary. And you can change those beneficiaries when you want.

Matt:

It's like a billion ears just perked up at the idea of oh, I can use this to really put one over on the kid. Fantastic. Of course, the problem is that those kids and grandkids won't value their future college education as much as you do. So in a way, you're not getting as much leverage as you thought. All right. All right. Attribution aside. So you're interested in setting up one of these accounts? Right? We know that, let's say you're the parent, you're going to be the owner, you're going to set it up for a beneficiary. You mentioned before, you don't need to fuss too much. If you have multiple kids about am I setting it up for the one versus the other? Because you could transfer that later?

Mike:

Yeah, but you do want multiple accounts. If you have multiple children. Well, you could change the beneficiaries. But there's gifting rules and other situations where you really just want to have separate accounts for those kids. Now, if you had one kid and then could 20 years later, or 10 years later, then you could change, they could use it and then change it the beneficiary leftover money. But typically, we've got kids that are a couple of years apart, they might be in college sort of at the same time. So you're spending the beneficiaries, you can't change kind of weekly, you wouldn't want to go in and out and change them. So want to have multiple accounts. For each beneficiary, they're super easy to set up, it's not something that you're going to get in there every week or every month like you do your checking account, it's going to be once a year that you kind of go in there, or you're going to set up some automated savings. So go ahead and set up one. And there's other reasons that you might want even more accounts, because we'll talk about state tax savings, because these 529 accounts are set up per state. And that's another reason you might want to have separate accounts, but in general setup, individual accounts, so you only have one beneficiary. Unlike trusts, you can put multiple beneficiaries, you can only have one beneficiary or on each 529. So if you've got multiple kids or grandkids, go ahead and set one up for each of them.

Matt:

So I think I recall that one of the major reasons in what you just said is, if you have the means to give good chunk of money, there are IRS limitations on how much you can give to your child.

Mike:in:Matt:

Right, right, right, right.

Mike:

So what you could do, if you are in the camp, we talked about this last episode that you know, you want to save 100% for their education, and you have the means to do that, when that child is born, you could give them $160,000 into a 529 invested 100% in the stock market and let it ride for 15-18 years. And then hopefully it grows to an amount that will be able to cover their college costs when you can track that over time, of course, but there's a possibility. ‘Are you ready to create your ideal lifestyle? Let's discover what's most important to you and design a plan to have more of that in your life. Go to meet Mike morton.com. All one word, meet Mike morton.com.’

Matt:

Now, here's, again, as we just kind of run through the logistics of doing this. Here's a good question you alluded a moment ago, to the fact that each state has its own 529, you could choose North Dakota, you could choose Nebraska, I hope I'm saying something nice to our listeners in those states. But normally, if I want to set up a new account, I start by choosing the financial firm that I'd like to use, like I want to set up a Vanguard account because they're famous for low cost funds. And so you know, like index funds, so I decided to go to Vanguard and I, I set it up through them. But with the state accounts, with the state probe 529’s, there is typically a financial firm that administers that particular states. So for example, if you live in Massachusetts, like you do, you've got to go through fidelity for that is so so how do you get started? Do you start by choosing the state and then figure out which financial firm to go to? Or do you start with the financial firm? Or what do you do?

Mike:

Yeah, so I would start with the state, you can choose you live in the in the US, you can choose any states 529, you don't have to choose your own states. Okay? The reason to choose your own, so you want to set up a 529. So let's get back to logistics, hey, I have have a child or grandchild, whoever I'm gonna set up a five to nine for their benefit, what do I do next? First, check your state tax savings for your 529’s. Some states offer a state tax savings for contributions to 529’s, other states do not what state tax savings they offer is different here in the state of Massachusetts, you can get up to $2,000 of contribution per beneficiary can be come off your state taxes. So it's kind of you know, 5%, or 5 ¼ % or 6%, whatever state taxes, you know, times the 2,000 bucks, you'd save about 125 bucks off your state taxes here in the state of Massachusetts, other states are different, I know the state of Virginia has way higher savings up to $10,000 per account. So if you contribute $10,000, you're gonna save that state tax times 10,000, you know, whatever the state percentage is times 10,000. It's gonna be big. And that could be if you have multiple accounts, and you do $10,000 each, it's you know, off $30,000. So each state has their own tax rules. So check that first.

Matt:

But that only applies to you if you file state taxes in that state. So what you're really checking is, is there a particular benefit to choosing my own states? Right?

Mike:bucks, are you saving:Matt:

Got it. So that's interesting, you got to start with the state. And then if you once you've made that selection, then you go to whatever financial firm or whatever interface administers that states 529.

Mike:

And just do a quick Google search, it will be the top results, I want to invest in Illinois, 529, it's, it's called Brightstar. If I want to invest in Utah, 529, it's like my 529 or something like that. So yeah, one Google search, you know, will tell you, and the Google search will also tell you your state tax deduction. Alright, so just say I live in Wisconsin, Wisconsin, 529 state tax deduction. And I'll tell you right there, like if you get one or not, now you were saying in our, oh, and that gun, let me just say to the state tax deduction is for contributions into a 529 in that year. So if you make $5,000 contribution every year, then you get to write on your state tax forms, I made a $5,000 contribution, take that amount off of my state taxes.

Matt:

Got it. Got it. Now, you were saying, in our episode on getting young people going on their retirement investments, that is really a three step process, it's a very easy three step process. You open an account, you put money into the account, and then you have to decide where it gets invested three easy steps. And actually, it's pretty similar with any investment you're making nowadays, you know, you open the account, you put some dollars into the account. That's right. It's not like you just put it in. And then you're done. Because you're they're going to ask, Well, what do you want us to invest that in? What's the answer on that when it comes to 529’s?

Mike:

Yeah, so that third part trips people up, right? Luckily, these days in sort of our 401k's you get default options now. So that's great, because we know default options work really well. Because yeah, people get tripped up on that third part, too many options back, we talked about that. But you know, in your 401k, you're going to have 20,30, 40 options. So it just sits in cash, right, you don't get to step three. So in the 529, same thing. Now luckily, most of them are going to have that default option. When you're setting up the account, boom, I'm going to open my account, put in my name and address and all my info and the beneficiary stuff. And then they're going to ask you, what do you want the investments to go into? Okay, so that you don't have to choose it every time you add 2,000 bucks, you don't have to keep choosing it, it'll automatically go into the investment options you chose when you set up the account. So that's good news. So what do you choose? I'm a fan of the age based index funds. And so they'll say, oh, yeah, like Illinois, or Utah. It's one of the reasons I like those lots of plans have them as well, where it'll say from zero to five, you know, your age zero to five, we do 100%, stock market, age 5 to 10, we do like an 80% stock market 20% fixed income. So as they get older, 10, to 12, to 14, it slowly has this less risky investment, so that when they go to college, the whole point is setting up for college savings. When you enter college, hopefully the stock market didn't crash 50% the year before, and you lost 50% of the money. Alright, so it has a slow de-risking over time. So when they're young, be more, you know, heavy risk and reward hopefully, and over time, you know, it's not going to get cut in half right before they go to college. So those are called age based portfolios, I like those, you could do the same thing yourself by just choosing 100% Index Fund, they're super young. And then kind of changing that every couple of years, you can change your investment options a couple of times only a couple of times during the year. And there's usually a limitation on changing those options. So make sure you pick something that's relatively appropriate, they usually make good suggestions for you on that. The other thing to be on the lookout from my perspective, is they often have index funds, or actively managed funds. Alright, I would always go with the low cost index funds if you listen to my episodes, and that's my belief investing is that you will outperform actively managed funds. So then 529’s are the same because they had these companies coming in there and saying, hey, let us actively manage your 529 we can outperform or do these these really sophisticated things and just pay a fee for all of our all our smarts. So I would recommend avoiding those going with just the index fund options inside the 529.

Matt:

I have to say that from my own experience, I found this pretty darn easy. I won't get into a ton of detail but when I set this up for my kids through the financial firm that administers in the state that I chose, I was immediately present because I think a lot of these interfaces for the big financial companies these days are very similar. It's the same idea. It's like where do you want to put your money and they offered what's essentially a target date fund based on your child's age and like you said it has this sliding de-risking feature to it. It's really a fire it and forget it type thing is it going to be absolutely perfect in all circumstances? No, but kind of averaged across everybody, it was a pretty darn good place to start really easy, just really, really easy to select. And I had a reasonable degree of confidence that I was the chances that I was doing something that was a little bit suboptimal, were about equal to the chances that I was doing something better than what I would have selected. So I felt fine. I felt I felt totally okay. But just an important step. And I did definitely choose the low cost index versions. I think that the expense ratio, it's not as low as you might get on, like, Vanguard retirement index fund target date, but it was pretty darn low. I, you know, I can't remember supplies, but I didn't make my eyes pop out.

Mike:

Well, here's, here's the thing about that. Yeah, just on that topic, you will see some fun fees. But what you don't see what I've done in that I told you, I looked at the 529 plans for a few different states. So I dug through their 30 page plan documents, and there's multiple fees that are added on top. So there's account fees, portfolio management fees, program manager fees and state fees, and the fund fees. Okay, so there's multiple potential fees, as part of what I scrub through when I got to the Illinois and the Utah being some of my favorites, you have to add up all across the board.

Matt:

Alright, so could you just run through? What can you actually use the money in your 529 for?

Mike:

Yeah, so the money and 529’s we talked about for education expenses, it's actually for qualified expenses around education. So you think of it typically around college costs. That's what these have been used for traditionally, so you're pre saving for expenses during college, such as tuition and fees, books, you can use it for computer technology and related equipment there. So a lot of things around the bulk of the payments for college. But beyond that you can use it for now you can use it for K through 12. Alright, it is capped at $10,000 a year. But if you have a private school tuition for K through 12, you can use up to $10,000 a year from your 529’s and that can be actually a really good point, Matt, that if you're in one of them, we talked about state tax deductions. Right? If you're in a state where you're getting a good deduction for that your kids in a private school, you could flow money straight into a 529 and out pay for this year's expenses at that private school and get a state tax deduction for that.

Matt:

Just kind of use it as a pass through basically

Mike:pass through. So if you have:Matt:

So you can do it after the fact you can you can come back and then use it up.

Mike:

Yep. So you can even come back, if you have some student loans, you can even use it for that, again, you could flow stuff through there, or if you've got extra money in there, you could use it for paying back some student loans as well.

Matt:change the beneficiary on the:Mike:

Yeah. First, I always tell all my clients, I've never been any met anybody that had the problem of having some extra leftover money. And that being like an issue or a big problem, it was money you're expecting to spend on education, and maybe your child didn't go to very expensive school, or they got scholarships, or whatever, for whatever reason, you have leftover money that you were expecting to spend, and now you have it sitting there. So that's a great problem to have. What can you do with that money. As we said, changing beneficiaries, of course, is the first one. Now you can change beneficiaries to a variety of people, it's got to be related to the current beneficiary, like a sibling, a cousin. So it could be like, if you're the parent could be your niece or nephew, you could change it to yourself, you could change it to your parents, you could change it to cousins, this is pretty broad, who you can use this money for, you can even let it sit in their mat for grandchildren. So invest it let it grow for another 20 years, you know, in case there are grandchildren, and you can even use it for that. So there's a variety of things you, you can hold on to the money and leave it in the five to nine now, say you run out of all those possibilities, and you just would like to spend this money, you could do that too. Alright, so you can take the money out, if you take it out for non qualified expenses, not education expenses, then you'll pay a 10% penalty on any of the growth and you'll have to pay taxes. All right, which is the whole point of that 529 is, of course, is that you're not really paying taxes on the growth and everything. So you have to pay the taxes on the growth, and then you'll pay 10% penalty. And like I said, have money you weren't expecting to have in your bank account?

Matt:

Actually, I was gonna ask about that. Because as we kind of wind toward the end here, what is the basic case for using 529’s is it that is that's right way to bury the lead here.

Mike:

So the whole reason to use 529’s, of course, is for tax savings. So what happens is just like some of these other accounts, you're familiar with your 401k, or your individual retirement accounts, your IRAs, the money inside of that account, once you contribute, money grows tax free, so any of the growth of capital gains interest in dividends, is all tax free. And then when you pull it out of the 529 to spend it on qualified expenses, then that's also tax free. So once you put the money in, then it's all tax free from there when you use it for qualified education expenses.

Matt:

So but just a better way to go than putting money under the mattress. So I can, just to sort of bottom line it, it sounds like, if you're gonna spend money on college, a 529 is a pretty solid option, you're gonna save some money on taxes, you might save additional money on taxes, if you happen to have a state plan in the state that you file, where they give that kind of a benefit. So you're gonna save some money, pretty broad range of uses. And you've got a fair amount of flexibility in terms of who the beneficiary is, you might even get the bonus of being able to get a little bit of leverage over your kids in terms of their life choices, is that basically the sum up there anything.

Mike:

Yeah, that's it if you're gonna, yeah, if you're gonna save for pre-save for education expenses, the 529 is a great option. And again, as we start with giving that confidence, that you're working towards your plan, something that that you value education and saving money for that makes you feel confident about having that for those future expenses for those beneficiaries.

Matt:

Mike Morton, Morton financial advice. Thanks so much.

Mike:

Thanks, Matt. Thanks for joining us on financial planning for entrepreneurs. If you liked what you heard, please subscribe to and rate the podcast on Apple, iTunes, Google Play Spotify, or wherever you get your podcasts. You can connect with me at link din for Morton financial advice.com I'd love to get your feedback. If you have a comment or question please email me at financial planning Until next time, thanks for tuning in. This recording is for informational purposes only, and should not be considered for investment advice. Opinions expressed as our of the date of recording. Such opinions are subject to change. We do not guarantee the accuracy or completeness of the data presented here.

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