Originally Aired: February 15, 2017
Topic: Saving for College with 529 Plan Expert Brian Boswell
The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
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- Introduction of Brian Boswell of SavingForCollege.com
- What Are 529 Plans and Their Advantages?
- What Expenses Are Covered by a 529?
- There Are Two Types of 529 Plans: Savings and Prepaid
- 529 Plans Vary by State, as Do Tax Advantages
- 529 Savings Plans Offer Diverse Investment Portfolios
- Assets in a 529 Affect Eligibility for Scholarships, Financial Aid
- 529 Beneficiaries and Owners Can Be Changed
- Roth IRAs Are Primarily for Retirement, Not School
- The Big Question: How Much Savings Is Enough?
- Overfunded 529 Can Become a Generation Gifting Tool
- Starting at a Two-Year School Can Save Thousands
Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.
1. Introduction of Brian Boswell of SavingForCollege.com
Dan Weinberg: And welcome to The Lange Money Hour, I’m Dan Weinberg alongside CPA and attorney Jim Lange. Tonight, we’re going to be talking about saving for college, focusing heavily on 529 plans, and our guest to help us do that is Brian Boswell, media-relations specialist and 529 expert from savingforcollege.com.
Brian has worked with 529s in multiple capacities since 2001. Among his jobs before joining Saving for College, Brian was director of advisor distribution to Ascensus College Savings, the leading administrator of 529 savings and prepaid plans. There, he oversaw the advisor-related business of ACS.
Brian has been quoted in leading publications, including The Wall Street Journal, Reuters, Investor’s Business Daily, Market Watch and Business Week among others. He received a Bachelor of Science from Rensselaer Polytechnic Institute and is the father of triplets, with significantly higher education expenses in his future.
Now, tonight, we’re going to tackle topics including: What is a 529 plan? How much should you save? Which 529 plan is best? How does a 529 plan impact financial-aid eligibility? And why not just use a Roth IRA to save for college?
So we’re looking forward to a terrific hour of conversation, let’s not waste any time. So, good evening, Jim, and welcome Brian Boswell.
Jim Lange: Welcome to the show, Brian.
Brian Boswell: Thank you very much, and I’m very excited to be on.
Jim Lange: So let’s just start out with a basic question. Let’s say that you are a parent or a grandparent and you have a child, a young child, and you know that the price of colleges goes up and you want to help that child out and you want to start a savings or some type of method of putting away money for college. In the old days, we used to do education trusts. What are people doing today?
Brian Boswell: Well, people have a lot of options available to them today, and it can be very overwhelming to select from the amount of options that are available to them. Whether that’s using a taxable account or investing directly in mutual funds, putting money away in a bank, using a Coverdell Education Savings Account or using their Roth IRA. But we generally direct people to a 529 college-savings plan.
2. What Are 529 Plans and Their Advantages?
Jim Lange: All right, so what is a 529? I assume that section 529 refers to a section of the Internal Revenue Code, and what is this essence of what that code number says or means to our listeners?
Brian Boswell: What that section of the code did was it established the ability for states and education institutions to create and sponsor education-savings plans. Typically, states that operate them, they are considered municipal securities, and what families can do is, they can invest in these plans with after-tax dollars and those dollars go tax-deferred or tax-free if used for higher-education expenses. Those assets can be used at any qualified higher-education institution, including four-and two-year private and public colleges.
529 plans are great because they’re really easy to use. You’ve lots of control over the assets in the account, there’s a lot flexibility in how you can use them, when you can withdraw them. There are federal, and in many states, tax benefits as well. The assets inside of a 529 are generally professionally managed and they’re monitored and overseen by multiple entities in most cases. There’s estate planning and gifting benefits; I could go on and on.
But there are many, many, many reasons to use a 529 savings plan. The first and foremost being their federal tax benefits. Go ahead?
Jim Lange: I think what you’re about to say is you put in money that you’ve already paid tax on and assuming that the money is ultimately withdrawn for a qualified education purpose, the money that you originally put in and all the growth on that money all comes out income-tax free.
Brian Boswell: That’s exactly correct.
Jim Lange: Which if you think about it, and let’s ignore the five-year rule, is exactly the way Roth IRA conversions are taxed.
Brian Boswell: Yes.
Jim Lange: Or at least the basics without getting into the exceptions, etc.
Brian Boswell: That’s correct.
3. What Expenses Are Covered by a 529?
Jim Lange: Let’s say that I’m a parent or a grandparent — we’ll get into the difference later on — and I pick a number 1,000, 5,000, 10,000 or some amount of money, and I put it into a 529 plan. Let’s say the child is 5 years old at the time. Now the child is 18 and he gets into the University of Pittsburgh and there’s tuition and there’s room and board and there’s books and there’s computers, what can the … and then of course there’s drugs and alcohol … what can the child legitimately use that money for?
Brian Boswell: Qualified higher-education expenses include everything you mentioned … well most of what you mentioned. It includes tuition, fees, room and board, computers and internet access. So, tuition, which is pretty straightforward, any fees associated with attending the institution. Books and supplies; so backpacks, pencils, that kind of stuff. Room and board, so that includes on-campus and off-campus. If your student wants to live off campus and save a few bucks, you can still have those expenses reimbursed by the plan. And board, same thing, if you do your grocery shopping off-campus instead of having a meal plan you can reimburse for those expenses as well. And most recently, computers and internet-service access were added as qualified expenses as well.
The obvious counter-question to that is, what’s a nonqualified expense? The easy answer is, everything else. Where we get the confusion is on certain expenses that you might think would be qualifying; for example, travel costs. You can’t buy a car for your student just because they need to drive back and forth to school. Doesn’t make it a qualified expense; it’s not required by the school for attendance. Air fare to get back and forth to school is not a qualifier. Insurance, health insurance for the child or student loans are not qualified as well.
Jim Lange: It sounds like it’s a pretty liberal provision, meaning that virtually any legitimate education expense would be covered.
So let’s say I put in $5,000, and let’s say it grows to 10 or $15,000 and, assuming that I am overseeing the plan for my child or grandchild, approves the expense and pays for it. Let’s just use the issue of tuition, let’s say that the tuition is for a particular course or semester is $15,000 and I have $15,000 in my 529 plan, I can pay for tuition. Is there any other type of 529 plan where instead of actually purchasing in effect an investment that’s going to grow with the market, if you will, where I can actually purchase credits or I can in some way have some type of safety play in the event that the inflation rate on tuition is significant higher than the investment rates?
Brian Boswell: Let me step back for a moment, because you said something earlier that I just want to correct. The plan doesn’t approve the expenses. All 529 withdrawals are self-reporting, so if you withdraw the assets, you need to be able to tie that withdrawal back to a qualified higher-education expense. But the plan doesn’t approve it and you never have to tell the plan whether it’s qualified or non-qualified, that’s something that’s self-reported. So if the IRS comes back to you and wants you to justify the expenses, they may do that and you need to be able to justify them. You don’t have to verify anything with the plan itself.
4. There Are Two Types of 529 Plans: Savings and Prepaid
Jim Lange: OK, so what about the question of buying credits instead of making an investment?
Brian Boswell: Yes, that is possible. There are two kinds of 529 plans; there are savings plans and then there are prepaid plans. There’s actually a third kind; I’ll touch on that in a moment. Savings plans work kind of like your 401K, where you put money in and you select your investments and they grow in a way that is pretty familiar with most investors. The prepaid plans operate more like a pension, where you put a set dollar amount in and it grows at the set rate, predetermined by the plan.
And that’s what you’re talking about, as far as you can purchase credit units in advance in certain prepaid plans. Now there aren’t as many prepaid plans around the country and there’s over 100 plans offered by most of the states, including the District of Columbia. Prepaid plans are more infrequent than you find savings, but for those plans that are out there, you can purchase tuition credits in today’s dollars and withdraw them in the future. You’d have to do a little hunting around because not every prepaid plan is open to folks nationwide, some of them are restricted to those in the state plan.
There’s also a third type of plan, it’s called the Private College 529 Plan. It’s the only institution-sponsored 529 plan out there. What that is, it’s a consortium of higher-education institutions who have gotten together and said “If you purchase units of our plan, then you can use those existing today’s dollars for future tuition.”
Jim Lange: That sounds like a Harvard-, Yale-, Princeton-type plan. Would that be the better, more expensive schools?
Brian Boswell: I’d have to take a look and check which schools are included in that consortium; I don’t know off the top of my head.
5. 529 Plans Vary by State, as Do Tax Advantages
Jim Lange: Let’s eliminate that for the time being because who knows where our kids are going to go school in 15 years or however many years between the time that we are putting money in and the time money will come out.
One question is, is either on the savings or the prepaid tuition plan, do you have to use the plan in your state? We’re actually broadcasting for Pennsylvania, but we do have a national audience. So if you could maybe say where you could chose a plan, whether it’s prepaid or savings, and what your options are and maybe some of the advantages and disadvantages of being in-state; that is a Pennsylvanian resident picking a Pennsylvania plan versus a Pennsylvania resident picking a Utah plan?
Brian Boswell: Every state is different, that’s one of the challenges in 529 plans is that they’re so varied from state to state. What you want to do is you want to check your in-state plan; you go on our website to check. All the information there is free; anybody can go on it and view what is offered by your in-state as far as perks.
Jim Lange: And by the way, before you go on, I want to tell our listeners what your generous offer is. The reason I got in touch with you initially is because I think that you and your company have the finest book on 529 plans there is. It’s called The Best Way to Save for College: A Complete Guide to 529 Plans and the author is a guy name Joe Hurley. It is still, in my opinion, an excellent book on saving for college. And Joe has since retired, Brian has taken over the spot and Brian is working on the next edition, but because the current edition isn’t quite up to the current, most recent information, Brian said, “Oh don’t push the book, just tell people to go to my website; I’m delighted if they go to the website.” So let me just repeat again, the website that we’re talking about and, for whatever it’s worth, I have used this website for years. It is excellent. You can find it at www.savingforcollege.com. Again, www.savingforcollege.com, and despite Brian’s worry that the existing edition of the book, The Best Way to Save for College: A Complete Guide to 529 Plans, isn’t 100 percent up to date — and that is one of his projects — it is still an excellent book, and if you needed information right now, you can either go to the website or spend 10 bucks or whatever it is on Amazon and get the book The Best Way to Save for College: A Complete Guide to 529 Plans by Joe Hurley.
Sorry for the interruption Brian, please keep going.
Brian Boswell: That’s OK, and I can talk a little bit more specifically to Pennsylvanian residents as well; you said your audience is primarily in Pittsburgh. There are two plans available to Pennsylvania residents: There is a savings plan and a prepaid plan. Your prepaid plan happens to only be available to your residents, and contributions to either plan, you do have a pretty significant in-state tax deduction as well, $14,000. And that adjusts up to the gift-tax annual exclusion. So you have a pretty significant in state-tax benefit that you can use towards your 529 contributions.
Could you perhaps repeat the question for me?
Jim Lange: The other thing I’m going to say about the Pennsylvania plan — and we have a little girl who’s … little girl? She’s 21. When we were initially deciding which plan we should take, Pennsylvania’s underlying investments was a set of funds called the Delaware Fund, which I was not a big fan of. I was a much bigger fan of Vanguard, and at the time, Utah used the Vanguard as the underlying investment, so our 529 plan was actually in Utah. Then, and I think it was a couple of years ago, Pennsylvania got out of the Delaware and now the underlying fund is Vanguard. They even have an option where it automatically adjusts the asset allocation as the child ages, meaning if the child’s 2, it’s mainly going to be stocks, if the child’s 17, it’s mainly going to be bonds and it’s easy and it’s quick and you don’t have to think about it very much. As you mentioned, there is a Pennsylvania tax credit also, so for Pennsylvania residents, at least for the saving plan, I think I’d have a hard time recommending anything else. Is that fair?
Brian Boswell: That would be fair. It’s a pretty significant in state-tax benefit. The plans themselves are quite good, either of the plans are quite good. Both of them are actually administered by my former employer, Ascensus College Savings, who is incredibly dedicated to the space. You get access to You Promise, which is a rewards service, where you can get money rebated back to you on purchases. So it’s a pretty good deal. They have excellent investment options, the expenses are pretty low, and it’s a great deal for Pennsylvania residents.
Jim Lange: Let’s go back to comparing the savings plan versus the prepaid-tuition plan, because I believe that tuition has gone up faster than an average investment rate. I’m no futurist, but it would not surprise me if the cost of tuition continues to rise. So let’s say for discussions sake that somebody’s not terribly optimistic about the market but they are fearful of significant tuition benefits, or tuition costs going up, would that person be advised to use the prepaid plan as opposed to the savings plan? And then the tough question, which I always love to ask, what are you doing for your own situation if you have triplets and you’re presumably putting something away for their college?
Brian Boswell:So the first question is, do you use a prepaid or a savings plan if you believe tuition is going to continue to skyrocket?
Jim Lange: Mm-hmm.
Brian Boswell: Honestly, that’s up to the individual investor. If you have significant concerns about tuition rising, the prepaid plan is a great deal. Historically, the rates of tuition have risen so much it caused some prepaid plans to actually close their plans to be able to meet those obligations. So prepaid plans can be a very, very good deal. The flip side to that is that you’re missing out on any potential market gains. So if the broader market, if the investment market performs better than you would have inside of a tuition prepaid plan, then you’re missing out on those potential gains.
Jim Lange: Do you have five- or 10- or 20-year estimates … not actually estimates, historical records of which one has done better? Let’s say a plain old SMP 500 index, which in a way is …
Brian Boswell: Versus the tuition-inflation rate?
Jim Lange: Right.
Brian Boswell: I don’t have it on hand. It’s something that I can get for you at a later date, though.
Jim Lange: That would be interesting, although in a way that’s not a fair comparison because again, if you go with the theory that you’re not going to want to think and you’re just going to let the plan decide the asset allocation, which is probably a reasonable idea for a lot of people, then you really can’t, to be fair, use a SMP 500 average because you’re going to have to have some bonds and an ever-increasing percentage of bonds and fixed income as the student gets closer to 18 years old.
6. 529 Savings Plans Offer Diverse Investment Portfolios
Brian Boswell:That’s right, and almost every 529 savings plan that’s out there, remember the difference between the savings and the prepaid plan, the savings plans are almost always going to offer you some diversified portfolio. Most offer an age-based product, where you put the money in and it grows on autopilot, becoming more conservative as the beneficiary approaches college age. Or a more static option where you can invest in a fixed portfolio of bonds, stock and market equivalents.
Jim Lange: And Brian’s website, which I think is just excellent, is www.savingforcollege.com. Again, www.savingforcollege.com. And the book that he is currently revising, but the one that’s in the bookstore right now, is called The Best Way to Save for College: A Complete Guide to 529 Plans and it is by his predecessor Joe Hurley, which is slightly dated but it is still an excellent (book).
Before the break, we were talking about the difference between a savings plan and a prepaid tuition plan, and Brian has young triplets and I asked him, “So Brian, what are you doing for your plan?”
Brian Boswell: So, I use a combination of savings vehicles. I do have some taxable investments, but for my college-savings plan I personally use a combination of Coverdells and 529s. I’ve maxed out my contributions to my Coverdells. The nice part about them being that I can invest in pretty much anything that’s on the brokerage platform. You have complete access to everything that’s on the mutual-funds supermarket. And then I supplement that with my 529 savings plans. I use two savings plans, in fact. One is my in-state plan, and the out-of-state plan. I use the in-state plan to maximize my tax deduction …
Jim Lange: Which state do you live in?
Brian Boswell: I’m in Massachusetts, and it starts offering a tax deduction next year. So I’ve just opened my account, started putting my money in to make sure I’m able to take advantage if it next year.
Jim Lange: All right, great.
Brian Boswell:Then I also use an out of state plan from my former employer.
Jim Lange:And which plan is that?
Brian Boswell: I happen to use the New York 529 plan, though that was primarily because my employer administers it. It’s an excellent plan. There are many great plans out there and I would have been just as happy using any number of others.
Jim Lange: I know that the New York used to use TIAA CREF; do they still use that or do they have a different underlying investment?
Brian Boswell: It’s administered by Ascensus College Savings, and they have a multi-manager asset lineup, including Vanguard.
Jim Lange: In my, let’s say development or changing in the investment world, I am going more and more towards the index world. Low cost and Vanguard would certainly be a great choice.
One of the concerns that people have is, “Well, gee, if I put money into a plan for my child or grandchild, let’s say I put in a fair amount” … and I think you mentioned the gift limit, which I guess is 14,000 or did it go up to 14.5? And if you’re married you can do two and then you can, at least in the old days, you used to be able to do five years at once.
So you could put away a lot of money in these plans, potentially overfund them, which we’ll get to anyway. But one of the issues is what if you put in a fair amount of money and then the child reaches 18 and … do you hurt the chances of the child getting any kind of aid or scholarship or financial help from the college or some institution?
7. Assets in a 529 Affect Eligibility for Scholarships, Financial Aid
Brian Boswell: So the answer is yes. 529s impact financial aid, but they have preferential treatment in the financial-aid formula. When I’m talking about the financial-aid formula, I’m talking about the federal financial-aid formula. You can’t really talk about how they impact it without talking a little bit about how that’s calculated. I’ll try and be very quick and to the point.
The federal financial-aid formula takes what’s called the EFC, the expected family contribution, into account. The expected family contribution is made up of expected contributions from your family, parents and students. Parental assets comprise the least, the smallest portion of that expected contribution, and student assets and incomes count the highest. Assets held in most college-savings vehicles outside of 529s would count as student assets. For example, UGMA, UTMA accounts would count as a student asset. But 529s count as the parental asset if it’s held in the name of the student or in the name of the parent. And when you make a withdrawal from a 529 plan, those withdrawals are not counted as student income in the future. You’re only getting the asset value of the 529 and only at the parental level.
Now, if it happens to be held by a third party for that beneficiary, or a grandparent, for example, if you’re a grandparent with a 529 for your grandchild, assets in the account won’t be counted at all, but once you make a withdrawal for the student, that withdrawal will count as student income, and that has a pretty significant impact on financial-aid eligibility. So if that is a concern, then you want to back load those withdrawals. As a grandparent, you want those withdrawals to start coming out in the junior year so that they won’t impact their financial-aid eligibility, assuming they graduate on time.
Jim Lange: Didn’t you just come up with basically a great strategy, which is maybe at least for a grandparent and at least … I probably have more grandparents of college-age children than parents, so I have been a fan of grandparents putting money in for a 529. And also as I understand, you can actually switch the beneficiary to not only siblings but also first cousins.
Brian Boswell: That’s right.
Jim Lange: Can you do it for anybody? Can I put in a 529 for the grandchild of a friend and then change my mind and say “No, I’ll do it for a grandchild of a different friend”?
Brian Boswell: First of all, I’m also a big fan of grandparents having 529s. If my mother-in-law is listening, I’m a big fan of you as well [laughs].
Jim Lange: Especially if you help with those triplets [laughs].
8. 529 Beneficiaries and Owners Can Be Changed
Brian Boswell: That’s right, any help is appreciated.
Yes, you can open a 529 account for anyone, related or not related. There are rules around switching beneficiaries, and there may be tax consequences if you switch from one sibling … there’s no tax consequences if switch from one sibling to another, another family member, but if you switch to a third party, then there may be tax consequences and you will owe …
Jim Lange: But that would be gift tax, not income tax, is that right?
Brian Boswell: You would have to pay taxes on earnings and a penalty as well.
Jim Lange: Oh, OK. No, we want you to keep it to siblings and first cousins then? If you’re a grandparent.
Brian Boswell: Correct. If you’re going to switch the beneficiaries, you want to generally keep it within the family to avoid any potential consequences.
Jim Lange: So that might be a really good way to do it for the grandparents to perhaps, in your words, back load, that is, plan to pay for the later years, which is a good idea.
Let me ask you this. Let’s say that tuition and maybe scholarships and 529s are not devastating to scholarships and other types of financial aid, but why not make life simple? Just use a Roth IRA, which is essentially taxed like a 529 plan, but it also has some other advantages because let’s say the kid doesn’t need the money or does get a full scholarship, the Roth IRA is not going to be considered an asset for the purpose of financial aid. Why not just use a Roth IRA in the name of either the parent or the grandparent, instead of a 529?
9. Roth IRAs Are Primarily for Retirement, Not School
Brian Boswell: There’s two reasons I talk about Roth IRAs as something … the Roth IRA is one of the best savings vehicles out there, and I don’t like to look at a Roth IRA or a 529. I like to say you should be using a 529 in combination with your Roth IRA. If you can maximize your Roth IRA contributions, you absolutely should. It’s a fantastic investment vehicle, and it does make life simple. You want to make sure, however, if your state offers a significant tax benefit, it may still be worth putting money into both the Roth IRA and the 529. And if you’re already maxing out your Roth IRA, remember you can only put in $5,500 a year into a Roth IRA currently …
Jim Lange: Or $6,500 if you’re 50 or older, like some of the people listening right now.
Brian Boswell: Yep, so they have the advantage of putting in $6,500 per year. Beyond that, and especially if you want to get up to the gift-tax limit, you can put it into a 529 and take advantage of the in-state tax benefit, especially for a Pennsylvania resident, as well as the benefits of using a Roth IRA. And also remember that a Roth IRA is considered much like a grandparent-owned 529 in that once you make a withdrawal from the Roth IRA, the income from that is going to count as student income on that year’s FAFSA. So it will count against their student aid.
If you were going to use both, and I hope that most people can, you would want to withdraw first from the 529 in the early years and then from the Roth IRA if you have to in the future years. But I really caution people against using a Roth IRA for college savings. The Roth IRA is a retirement vehicle and you really want to, if you can, stretch that out for your own retirement because you can’t borrow for retirement, but you can borrow for college.
Jim Lange: By the way, those are very wise words which I wish more people would listen to because unfortunately, and this is a little bit off topic but I actually think is very relevant, is that many of us including me had our college tuition paid for by our parents. The deal that my parents made with me is they would pay for an in-school tuition, if I wanted to go somewhere else that’s fine but the difference was on me. When I found out what the difference was I chose to go to school in state.
Unfortunately today, as a percentage of net worth, the cost of colleges are so much higher than they were say 30 or 40 years ago, that a lot of people who, particularly grandparents, who had their college taken care of and it wasn’t such a huge burden for their parents. Some of them are now grown up, they want to help their kids or their grandkids and sometimes if they are paying the full fare with a 529 or direct or indirect or anything else, the only way that they could effectively do that is to borrow money or to not save enough for themselves. And what you just said is you said you can’t borrow for your retirement, and other then a home-equity loan, that’s so true. So one of the things that I sometimes have to caution people is, “Yes I know that your parents paid for your college, but if you pay the entire bill for your kids college, you’re just not going to have enough money to retire or you’re going to be committing yourself to working until you’re 70 or 75,” which has two problems. One, you might not want to, and two, you might not be able to.
Little bit off point but I think what you said about you can’t borrow for your retirement is very, very accurate, and it’s not totally clear to me that it is absolutely wonderful to have every nickel paid for … I would agree that a student coming out of school with $150,00 debt is a huge problem. But if they come out with a little bit, I’m not so sure that that’s horrible. They have a little bit of skin in the game. That’s more a psychological issue; I don’t know if you care to comment on that or not.
Brian Boswell:I think that it’s a great idea for the student to have a little skin in the game as well. Gives them a vested interest in the actual cost of the school and incentive to pick a career path that will help them actually pay off that debt once they get out.
Jim Lange: I know personally … my parents paid for state school and I went to Penn State and I played a lot of table tennis and I played on the chess team and I had a great time. I was an OK student but not a stellar student. Then later when I went to law school, everything was on me, and then all of a sudden I’m a stellar student — interesting how that happens.
Anyway, so basically you’re saying Roth is really for retirement and you love Roth, but you don’t look at it as an “either or,” you would actually prefer to do both.
Brian Boswell: Yes, if you qualify. The main drawback of the Roth IRA is that you may qualify out of it. You have to have income below a certain amount in order to be able to use it at all.
Jim Lange: Unless you use our backdoor Roth IRA, which actually Congress is trying to eliminate. That, by the way, is when you take your money in your IRA … are you ready for this? You roll it into your 401K, so now you don’t have any IRA. Then you make a nondeductible IRA contribution, and then later on you make a Roth IRA conversion of that nondeductible IRA and it doesn’t cost you anything. That’s just a little trick that we’ve been using. Natalie Choate and a few of the IRA experts say you have to be a little bit careful, and you never want to do that if you have an existing IRA because you can’t mix the coffee with the cream. That is, the after-tax with the pre-tax. Let’s just say there might be a way around that.
Brian is the expert that took over the website from Joe Hurley, who wrote a very fine book called The Best Way to Save for College: A Complete Guide to 529 Plans. It is slightly dated but I still think it is the best book out there. Brian, because he is just very meticulous, says that he likes for people to go to his website, which is absolutely up-to-date.
Anyway, where we left off is, I had suggested that maybe it’s not 100 percent necessary to pay 100 percent of your children’s college costs. That maybe if they have a little bit of skin in the game that, that’s not necessarily a bad thing in terms of motivation and in terms of their desire to work hard and their desire to come out with a degree where they might actually get a job.
That partly relates to the issue of how much money people should be saving and we’ll talk about what happens if you overfund these 529 plans, but can you give us some guidelines, Brian, on how much money a parent or grandparent with very young children should be thinking about saving per child?
10. The Big Question: How Much Savings Is Enough?
Brian Boswell: Right, and that’s the $400,000 question: How much should I actually put away?
Jim Lange: Now is that the answer, $400,000?
Brian Boswell: How much do I put away for the enormous potential future cost, and what is that cost? So, there are lots of tools out there to help folks start out by estimating what the cost might be eight, 10, 18 years down the road depending on when you actually start saving. You can never start saving too late, by the way. If you go our site, there is a college … it’s called the World’s Simplest Calculator and you can put in the age of child and it will give you an estimated cost of what it would be to attend school in how many years you have left to save.
And that’s what I call the jumping-off point, that’s your diving board. That number is the number that will start putting things into perspective. You’re going to get a big number pretty much no matter how old your child is. When I put in my children, in total for the triplets, it’s $1.1 million for them to attend the same school I did.
But I’m not going to pay $1.1 million for my children to go to school. Most of the costs is covered by scholarships, grants, student income and borrowing. And once you get down to it, the actual parent income savings is closer to 30 percent of that total cost. So now you’re taking that $1.1 million cost and needling it down to $325,000. Then I can start breaking that up over monthly payments in funding up to 30 percent of the projected cost, rather than 100 percent. And every family is going to have a different target for that, expect different amounts off of their children, but ultimately the number that you can afford is going to be a number for you to decide based on what your other commitments are.
Jim Lange: Let’s go backwards, let’s say you have a grandparent who is very education-oriented and he wants to put in the maximum. So I think that you mentioned that you can get a state benefit if you put in the gifting amount, and at least in the old days you could put in up to five years at once. So you could put in a lot of money, and I’m sure that there are some listeners out there who have 529s and either because the investments did well or they actually overfunded it or maybe the child did get some type of tuition break or some type of scholarship, that there’s money left over. What happen if there’s money left over in a 529 plan, which presumably would have some impact on how much money you put in because what happens if you put in more money than is needed? The kid’s done with school and there’s still money there, what happens then?
11. Overfunded 529 Can Become a Generation Gifting Tool
Brian Boswell: If there’s money left over afterwards, you are my personal hero, that’s what happens first [laughs]. It’s very hard to overfund a 529 for most people, but for those that do, you don’t have to do anything. That’s one of the greatest benefits of the 529 versus other savings vehicles is that the money can sit in that account and continue to grow tax-deferred. You don’t have to do anything with it, you can change the beneficiary down the line, so if you have another child that could benefit from that money, you could continue to save for their education. You can continue to save indefinitely, maybe for your own grandkids down the line if you have grandchildren, or even go down further and keep going on to your great-grandkids.
Jim Lange: The children of the college-aged beneficiary.
Brian Boswell: Because you can change the beneficiary. You can also change the account owner, although you’ll have to check with your respective state to see if there’s any tax implications for doing so. It becomes really a generation gifting tool at that point.
But if you don’t want to continue to use it for higher-education expenses, you can make a nonqualified withdrawal and close off the account. In that case, any excess that you’ve put in, you’ll pay whatever your tax bracket is on earnings, and that’s when it changes from a tax-free savings vehicle for higher education to a deferred-tax savings vehicle where you’re paying you current earnings rate at the time that you take it out plus a 10 percent penalty because you’re making a nonqualified withdrawal.
In that case, you want to check and see if there are any scholarships or other situations where you might qualify for an exemption. There are a number of exemptions for making a withdrawal from a 529 plan, at which point you wouldn’t have to pay the penalty. You can withdraw the amount of a scholarship that was earned in a previous year and not pay the penalty on that; it will pay for earnings.
In the unfortunate event that the beneficiary were to pass away during college you can make a full withdrawal without penalty, again you’d have to pay taxes. Or if they attend a military academy, such as West Point, they can make the withdrawal penalty-free as well.
Jim Lange: By the way, years ago, I don’t know if it’s still accurate, years ago I did a calculation that said if you kept the money in there for 24 years, that the advantage of the tax deferral made up for having to pay the tax and the 10 percent penalty. If you have a long investment horizon, even if you don’t plan to use it for education, it’s not maybe the worst thing in the world to keep it in there.
Brian Boswell: That’s right. I don’t know what the exact cut off, it may still be 24 years …
Jim Lange: Well, that’s an internal calculation, there’s no official … that was based on a bunch of assumptions that I used.
Let me ask you one question that is perhaps a little bit outside your area of expertise because you sounded fantastically knowledgeable about the taxes and the implications and comparing it to a Roth and the advantages and disadvantages. I’m going to get a little bit more philosophical and a little bit more big picture, and I’m thinking of some of the people … if you can afford, either because you have enough money for your child or maybe your grandchild, for that child to go to Carnegie Mellon if we’re talking locally, which is an expensive school in Pittsburgh. Or Harvard or Yale or, for that matter, any of the Ivys, or even some of the private schools are very expensive.
I’m going to go back to what I said earlier, that some people are just going to have a problem paying full board, even with the 529 and maybe even with some scholarships. That they’re going to have a problem actually paying for their kid’s college and at the same time sufficiently funding their retirement plans. Even though perhaps their parents paid full fare on an expensive school or at least a state school, there is, I suspect, a growing trend of people who are saying, “Hey look it’s just too, too much.”
Why not just go perhaps to a community school like CCAC, that’s Community College of Allegheny County. Or even a state school like University of Pittsburgh or Penn State, if we’re going to use Pennsylvania examples … which by the way handily beat Ohio, which was a lot of fun to watch. Why not use one of those schools for maybe two years and if the child is really smart enough and motivated enough to get into an Ivy League or to get into CMU or one of the better schools, transfer. And that way, if the child kind of screws up their first year or two, instead of costing $60,000 it might cost $10,000. What do you think of that, and do you have any experience in that area? Either anecdotally or from what you have seen?
12. Starting at a Two-Year School Can Save Thousands
Brian Boswell: I have a niece that’s approaching college age now and she’s interested in going into nursing or another medical field and this is an option that’s she’s considering herself because it is very expensive to attend a lot of four-year private institutions. So she’s looking at doing a two year to bring down that overall cost. Taking that two years of schooling and then transferring into a four-year school to bring down the net cost.
I think it’s tremendous strategy to do that for families that might not otherwise be able to afford a four-year institution. Potentially, you might be getting a better education at the four-year school. There are lots of great two year-schools; I’m not saying that an education at one or the other is better, but you’re forgoing two years at that school that you otherwise might get with a full four years there. But from a financial standpoint, it’s a fantastic strategy to bring down your overall cost.
Jim Lange: Actually, that’s a perfect example. Presumably, let’s say that she carries through with this plan, and let’s say that somebody who’s just as smart and has the same talents goes to the school where your niece is going to end up. The other person who went four years, and let’s just say for discussions sake that tuition and other costs is $50,000, and let’s say whether it’s out-of-pocket or 529 or whatever it is — and by the way, that’s assuming we have a four-year degree and not more, let’s say the cost there might be $200,000. Where your niece might get two years of say $10,000 and two years of $50,000, so she’s looking at about $120,000. There’s about an $80,000 difference. They’re both going end up presumably with a degree from the same school, and it’s not clear to me that the person, that your niece, would be in a worse competitive position than the person who went all four years, but the family saves $80,000.
Does that make sense to me? And by the way we have about two minutes left, so why don’t you answer that and anything else that you want to comment on. Again, Brian Boswell, savingforcollege.com.
Brian Boswell: I think it’s a great strategy and that ultimately you’re going to college to get a great job, right? And when you’re going from school to apply for those jobs, they’re looking at the name on your degree. The name on the degree is the same whether or not you went there four years or two years and transferred credit. So you’re going to be just as qualified of a candidate as you would be if you attended all four years from an employer perspective.
Financially you’re going to be in a better place and potentially have lower borrowing costs if you’re in that type of financial situation. It’s just absolutely a fantastic strategy to pursue. Even if it’s not something you end up doing it’s something you should be familiar with and look into from a funding standpoint.
Jim Lange:Brian you’ve been a wealth of information, I thank you so much. Again, we’re here with Brian Boswell, who took over the site savingforcollege.com from Joe Hurley. The most recent edition of Joe’s book, which I still think even though it’s slightly dated is still excellent. The book is The Best Way to Save for College: A Complete Guide to 529 Plans and the website savingforcollege.com. The website is updated, the book is slightly dated.
Thank you again for agreeing to be on the show Brian and sharing all your wisdom.
Brian Boswell: It’s my pleasure.
Dan Weinberg: Thanks Brian, and thanks of course as always to Jim. All of The Lange Money Hour episodes are archived soon after they air on the Lange Financial Group’s website. www.paytaxeslater.com, just look under “Radio Show.”
Special thanks as always to the Lange Financial Group’s marketing director, Amanda Cassady-Schweinsberg, and to our producer here in the studio, KQV’s Amy Velella. I’m Dan Weinberg for Jim Lange; thanks so much for listening and we’ll see you next time on The Lange Money Hour, Where Smart Money Talks.