People love to compartmentalize savings by goals. It’s easier to manage and track your progress if you can save for college, retirement, emergencies, home remodel, etc. in individual accounts. So when it comes to saving for your child’s education a 529 can be a great place to put your money for all practical purposes. The account is specifically designed for education and performs similar to a Roth IRA. You contribute on an after-tax basis but gains are tax-deferred and withdrawals used to pay qualified education expenses come out tax-free. Taxes can have a significant impact on your savings potential, so the tax mitigating benefits of a 529 seems like a natural fit for your college savings. So, what could possibly be the drawbacks?
You can find many online articles by financial organizations and professionals highlighting the disadvantages of a 529 plan, including limited investment options, potential impacts to financial aid eligibility, short time horizons, and the most common of all, the potential for tax and/or penalties if you don’t use the funds to pay for education expenses. Now all of these disadvantages hold water and should be weighed against some pretty powerful benefits. However, in my professional assessment, the worst thing about a 529 plan is that you have to drain the money in the account to pay for college and cannot fill the bucket back up to save for your own financial future. Now this might seem like no big deal since you’re saving in various accounts for your other goals, but let’s take a deeper look.
Many parents are in their peak earning years by the time their kids’ graduate college and thus start looking for places to save more money. They know they haven’t saved enough. They were so overwhelmed paying for massive education expenses that they weren’t able to put as much away for their future as they had hoped. But, now those expense are done, the kids are out of the house and they’re looking to sock away significantly more money than they were able to during the child rearing years. The natural solution is to contribute to their retirement accounts, but those can be quickly maxed out leaving them with no efficient place to save their money. In addition, when they were forced to drain their 529 savings to pay for college, the power of compound interest was instantly interrupted and killed. The money they withdrew was gone forever, and what they could have earned on that money in the future was also lost forever.
It might be simpler to compartmentalize your savings into certain accounts by goals, but is it efficient? If you’re heading from Boston to Los Angeles, you can take many different modes of transportation to get there, such as cars, buses, trains or airplanes, but which mode is most efficient? What if instead of saving in a 529 you could save after-tax dollars in an account that allows you to defer the taxes on the growth, take the money out tax-free (for whatever purpose you want) and then fill that account back up for your own retirement? Would that benefit you? In addition, what if you had the option to access your money without interrupting compound interest? Would that help you manage your money more efficiently? 529s are not a bad savings vehicle by any means. The question you should be asking is whether or not a 529 provides the confidence and efficiency you’re looking for in achieving your desired outcomes.
This material is intended to be educational in nature, and not as a recommendation of any particular strategy, approach, product or concept for any particular advisor or client. These materials are not intended as any form of substitute for individualized investment advice. The discussion is general in nature, and therefore not intended to recommend or endorse any asset class, security, or technical aspect of any security for the purpose of allowing a reader to use the approach on their own. Before participating in any investment program or making any investment, clients as well as all other readers are encouraged to consult with their own professional advisers, including investment advisers and tax advisors. Harmon Wealth Management can assist in determining a suitable investment approach for a given individual, which may or may not closely resemble the strategies outlined herein.