What do you care most about in life? If you have children, it is likely them. While there are many important facets of parenthood and to preparing a child to be successful, providing them with the opportunity of a quality education is one of the most important facets. Knowledge can never be taken away. A college degree is an asset that does not decay and cannot be lost or stolen, and it will benefit them for the rest of their life. But, a quality education rarely, if ever, comes cheap. That is why we work so hard for our children: so that we can afford to give them an advantage and allow them to achieve their potential.
To the end of taking care of our children as best as possible and doing so in an economically intelligent manner, a 529 plan is a smart move. Excitingly and descriptively named, a 529 plan is named after Internal Revenue Code 529 – only the IRS could create such an energizing name for a benefit to save families money.
However, despite the banal name, these plans are incredible. Let’s see them in action with a hypothetical example of how they could be used:
- Initial Deposit: $5,000
- Monthly amount deposited: $500
- Number of years saved for: 18
- Total ending account balance: $227,359
- Amount of money put into account: $108,000
- Amount gained from compounded earnings (assuming a reasonable 7% return): $119,359
- Tax bill on earnings if taxed at 35%: $41,775.65
- Tax bill on earnings if invested in a 529 plan: $0
Although deposits are not tax deductible (though some states do give a deduction on state taxes for contributions), the earnings on these deposits are tax deductible for both state and federal taxes if the withdrawals are used for education expenses. Under the above scenario, a family would save $41,775.65 by investing that money into a 529 plan.
Additionally, after the recent tax reform, the money in 529 plans can be used for more than just college education expenses and can be used for all education expenses (up to $10,000 per year for K-12), including tutoring for academic subjects in middle school and high school and even the SAT and ACT.
If you want to be a true pro at using a 529 plan, consider the following: You can switch the beneficiary listed on a 529 plan. Doing so is typically used if one child does not need the entire balance of his or her fund. This option, however, further allows parents to open 529 plans in their own names and transfer them into the names of their children – even if parents open the plans before they have children and are even parents. This means that even future parents can start saving for their children’s educations, and the money in these accounts has more time to accumulate, which maximizes the tax advantage of tax free gains on the investment.
Here’s a scenario: Your child, Elijah, turns 18 years old and he (or you more likely) opens a 529 plan in his name with himself named as the beneficiary to start saving for his children when he eventually has them. If Elijah has his first child when he’s 30 years old, then that account will have already accumulated for 12 years. Eighteen years later, when his first child becomes an adult and begins college, that account will have accumulated for 30 years in total. With the same scenario as the hypothetical example given above (initial deposit of $5,000 and $500 deposited monthly for 18 years – so assuming the last 12 years there were no contributions and the account only grew from compounded gains), the account will have grown to $512,056. That’s an extra $284,697 just for having the account for 12 more years even without putting any additional money in (and a total gain of $404,056 – almost 4 times the $108,000 you invested). Tax savings on the tax free $404,056 in gains: $141,419.60.
“Knowledge is power” (Francis Bacon). Let’s use our knowledge to empower our children.