Should you open up a 529 plan? This is a common question in personal finance.
I don’t think there’s a black and white answer but this post is going to give you five things to think about so you can make an informed decision.
What is a 529 Plan?
First things first, let’s define what a 529 plan is. It’s a tax advantaged account to save for a child’s education. The growth is tax free and withdrawals aren’t taxed as long as the funds are used for qualified educational expenses.
5 Things to Consider
I can’t tell you whether to open up a 529 plan or not but I can give you some things to think about. This will be coming from a perspective of your child being somewhere between the ages of newborn to early teens, where college is still several years away.
Number 1: Future Value of College
It’s impossible to predict the future. I don’t have a crystal ball to tell me what the value of college is going to be 10+ years from now.
I can reasonably guess college will still be valuable, but I don’t know that for sure. Assuming it’s valuable, I don’t know how valuable.
Will some or most higher level careers require a degree? Or will it be a low percentage? Will only certain majors be valuable?
Is it possible that college will only be for a select few? Or could higher education become so saturated that it’s not as valuable? It could go in a lot of different directions.
Number 2: Scholarships and Grants
I think most people would agree that the costs of college are through the roof and largely unsustainable. A family of four with a median income is unlikely to be able to afford the costs of an undergraduate degree.
As of this writing, there is a lot of money available in scholarships and grants. I don’t know what that will look like 10-20 years from now but if costs continue to spike and college is valuable, I would guess that scholarships and grants will play a big role in funding an undergraduate degree.
Using a hypothetical situation where a student (only child) gets $35,000 per year in scholarships and grants, with tuition being $41,000 per year. That leaves a $6,000 gap to cover every year for four years for a total of $24,000
If the parent(s) of that student saved $150,000 in a 529 plan, they have way overshot the amount needed. By over $125,000!
A good problem to have, but a problem nonetheless becomes that money could have been invested in the parents retirement account or somewhere else.
There are some different strategies the parents could use like convert a portion to a Roth IRA, use the money for a relatives education, etc but there’s a good chance they’d end up paying the penalty on a large portion of the money.
Number 3: Career Value
When your child is ready for college, how much career value will the degree have? If it’s required in their field, a great deal of value I would argue. Plus the intangibles that a higher education can provide.
If there’s no career value, or a very minimal amount, it’s a different story. A student who earns a liberal arts degree and goes into a field that doesn’t even require a degree isn’t getting an optimal return on the investment. As mentioned above, there are the intangibles a degree offers but that is hard to quantify.
If there’s no career value (or very little) will a prospective college student want to spend four years of their life pursuing a degree that holds minimal value? Maybe they will, maybe they won’t.
Secondly, imagine a parent who has $150,000 or more saved in a 529 plan. How will they feel knowing they are going to spend the money on a degree that won’t be all that helpful, or have to figure out something else with the money? My guess is they’ll feel like they should have invested the money another way.
Number 4: Will Your Child Want to Go to College?
This is a question I’d imagine not a lot of parents want to face. What if your child doesn’t want to go to college? Instead, maybe they want to:
- Go straight into the workforce and start making money
- Work abroad for a few years
- Start a business
- Apprentice in a trade
- Etc, etc
There are literally dozens of other things a young adult can choose instead of college. College might end up being the best choice but it’s important not to discount that an 18 year-old is going to have aspirations and dreams that may or may not include college.
If your child ends up not choosing college, what to do with the pile of money in the 529 plan? Take it out and pay the fees and taxes, use it for another family member? There are some options but they are more limited and not as attractive.
Number 5: Government Subsidies
As college continues to be more and more expensive, is it possible that the government could create subsidies for students to attend college at a more affordable price?
I don’t think it’s out of the question. If that were to happen, what would a parent do with the money in a 529 plan? And if they could turn back time, would the money be invested another way?
Bonus Alternative Strategy: Start Compounding Now and Pay Out of Pocket or Use Those Assets to Pay for College
I’m going to give you my strategy for my kids’ college. It’s right for us but it’s not going to be right for everyone.
We decided to invest in rental properties and tax advantaged retirement accounts. This strategy allows compounding to begin early and continue as we enter retirement years.
Our thinking behind the strategy is the longer you give money time to compound, the more likely it’s going to keep pace with historical averages.
For example, $1,000 invested every month for 20 years at a 10 percent rate of return would be approximately $756,030 in 20 years. However, in 30 years that money would be approximately $2,171,321. That’s a massive difference of $1,415,921!
That extra 10 years of investing allow compound interest to work its magic and is worth almost 1.5 million dollars. That’s life changing money.
The strategy then is to backload any college expenses later in our working careers, either out of pocket or pulling from investments if needed. Or a combination of the two.
There’s also a good chance that one or both of us could be making more (inflation adjusted) by then so we’ll have more flexibility to pay out of pocket.
The logic behind it being that the money coming out of our income is less valuable than the money we began investing years ago because of the power of compound interest. This also gives us the flexibility to do something else with the money if our kids get scholarships, grants, don’t attend college, etc.
Conclusion
With the insane costs of a four year degree and advanced education, my belief is something has to change with higher education. I just don’t know what, when, or how. What’s happening currently is not sustainable though.
I can’t predict the future but I can reasonably predict a few different scenarios and plan accordingly. With any financial strategy, I look at multiple different possibilities and then create a strategy that best fits a variety of possibilities, and I’m doing the same for college planning.
Have you opened a 529 plan or do you have other ideas?
