Tax savings matter, but choices matter more.
I recently had my second child. As someone who has always considered himself financially prudent, forward-looking, and disciplined, I opened a college savings account (529 plan) for her the day her Social Security number arrived in the mail. I had saved enough cash earlier in the year to fund this account to the maximum $15k amount before incurring the gift tax. I’ve always liked the benefits of a 529 account, and also believe that many investors are not aware of just how flexible this type of account actually is.
At this stage, the combined amount I have saved in these tax-advantaged accounts for my two kids will likely fall short of their higher education expenses, even after growing in the market for the next two decades. That said, I do not intend to invest another penny in the 529 accounts for either of my children. I’ve outlined my thought process below…
Real quick, what are 529 accounts and why are they awesome?
A 529 account enables parents to save for their children’s college tuition or other education expenses, including things like housing and books. The account is essentially like a Roth IRA specific to education, funded with after-tax dollars but growing tax-free. It can then be withdrawn tax-free for these education expenses. If withdrawn for anything other than education expenses, it will incur taxes as well as a 10% penalty.
Notable points of flexibility with a 529 account include the ability to transfer funds between siblings, and also to pass to future generations. If your child receives a scholarship or grant of some sort, the amount the child receives can be withdrawn from the 529 account without tax or penalty, providing additional protection.
If that sounds pretty great, it’s because it is. So why am I stopping contributions now even when I will likely have under-saved in these accounts by the time my kids are in college? There are 4 key points that I believe outweigh the benefits of any further 529 contributions…
I want zero risk of over-saving in these accounts.
Given the rising costs of higher education, this risk appears low. However, 20 years is a long time and the education landscape could potentially look very different at that time. With many of today’s millennials buried in student debt and largely regretting the costs they incurred, it would not be shocking to me to see large government subsidies for college expenses by the time it impacts my kids. I’m certainly not counting on that, but I recognize it as a possibility and do not want to be stuck with a huge surplus that I can’t withdraw without penalty.
I believe that formal education and fancy degrees are losing their value.
I have a 4-year degree, an MBA, and have worked in tech for 13 years. Not once have I felt that the MBA opened opportunities I would not have otherwise encountered, and my Bachelor’s degree at the onset of my career was simply table stakes. I went to what I would consider being a good but not great school, and still typically found myself in the same socioeconomic circles as those who paid considerably more to attend Ivy League schools.
The tech industry, in particular, has largely democratized opportunity across varying education levels (though certainly not across race and gender), to the point where it appears foolish to over-invest in an expensive degree. While tech certainly doesn’t represent every industry, I do think this concept will permeate across other industries in the future.
There will always be certain fields of work where the gravitas of a degree still matters. I would expect this to be the case in industries where the degree itself is a prerequisite to do the work, such as medicine or law. However, for the vast majority of jobs, I would anticipate rapid expansion of specialized certifications that cost far less and better prepare young workers to add immediate value to an employer.
My kids might not want a handout.
I have no idea how my children will feel about taking our money for their education as they get older. I view it as an investment in them, but I also appreciate the independence and accountability that would come from them WANTING to take care of themselves at an early age. As long as they don’t go into debt to do so, I would respect that choice. To me, it’s not worth taking loans just for the sake of establishing work ethic and cutting their teeth into adulthood (they can learn those lessons in far less expensive ways).
Flexibility above all else.
529 accounts are excellent investment vehicles. However, they are limited to a specific function — one which I am unclear on how much I will need. A good comparison would be a Health Savings Account (HSA), a tax-efficient savings instrument for health expenses. One big difference, however, is that an HSA essentially acts like an IRA or 401k once you reach retirement age. Thus, if you don’t have the health expenses for which you can use your HSA, you can still repurpose it for retirement with no penalty (though you would still pay income tax on withdrawal, similar to a 401k). A 529 account unfortunately does not have the same flexibility.
Flexibility is the single biggest idea that I am optimizing for as I plan for the future. If I end up with a shortfall on my children’s education funds, I hope to have enough saved across other areas of my portfolio which I can happily repurpose for them should they ever want or need it. For now, I’m done earmarking any new investments for specific expenditures.
As a final takeaway, invest into growth vehicles to a risk level you are comfortable with. As long as you balance tax optimization with liquidity and versatility, you can adapt to any unforeseen circumstance. You and your children will both be better off for it.
Disclaimer: This article is intended for informational purposes only and should be considered financial advice. You should consult a financial professional before making major financial decisions.
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