Early and Often: A 529 Recipe For Success

Wow! How time flies, summertime in particular. As we enter the last week of July, I thought it might make sense to sit down and revisit the joy that the spring and early summer have brought to our family and those around us. This June we hosted a wonderful gathering of our family and friends to celebrate a dual graduation. Our middle child, Conor, graduated from Quinnipiac University with a degree in communications and a concentration in sports media. 

Like many Americans, sports, whether participating or watching, have always served as a central meeting place, a town square for both our nuclear and extended family. As our middle, Conor has always been our articulate, fair-minded observer. It seems most appropriate that he should follow his passion for words and sports and land his first job with WFAN & Infinity Sports Network. All those that know and love him would agree. As Confucius stated, “Choose a job you love, and you will never have to work a day in your life.”

Megan, our youngest, graduated from high school and is heading to the University of Pittsburgh School of Nursing. At Pitt, Megan will follow her head and her heart toward a career where her fearless, empathetic nature will strive to care for others.

I tell you this as we have attended many graduation celebrations this season and the subjects of college and, in particular, college funding inevitably come up. Our three kids are  seven years apart. This has created a fun dynamic, as we have friends that are significantly older and younger than we are. 

Given the wide spectrum, I am often struck by the fundamentally divergent opinions people have about 529 college savings accounts. Many have had great experiences with them, and some have not. I will try to explain where I think some go wrong and what I view as best practices to achieve college savings success.

Skipping the Numbers

One of the most fundamental mistakes people make with 529 plans is not engaging with the numbers. Understanding how much you need to save requires careful planning and calculation. Start by estimating the future cost of college, considering factors like tuition, fees, room and board, books and other expenses. Use online calculators that consider the current cost of education and inflation rates to get a realistic figure. Next, assess how much you can consistently contribute each month or year. Failing to do the math can lead to underfunding your plan, which might leave you scrambling to cover costs when your child heads off to college. Conversely, overestimating can result in having excess funds that could have been allocated to other financial goals.

Delaying the Start

Delaying the opening of a 529 plan is another common error. Many families either put off opening a plan or are overwhelmed by the options and complexity, leading to procrastination. The power of a 529 plan lies in its ability to grow tax-free over time, so the earlier you start, the more beneficial it will be. Even if you can only contribute a small amount initially, starting early allows for compounded growth, which can significantly increase the value of your savings over the years. Procrastination can also mean missing out on state tax benefits and other incentives designed to encourage saving for education.

Ignoring Risk Adjustments

Investment risk tolerance should evolve as your child grows closer to college age, yet many people fail to adjust their investment strategy accordingly. When your child is young, you have a longer time horizon and can afford to take on more risk with higher potential returns. However, as college approaches, it is prudent to shift towards more conservative investments to protect your savings from market volatility. Many 529 plans offer age-based investment options that automatically adjust the asset allocation as your child gets older. Regularly reviewing and adjusting your risk tolerance ensures that your savings will be there when you need them most.

Stopping Contributions Too Soon

A common misconception is that contributions to a 529 plan should stop once the child starts college. However, continuing to contribute during the college years can be highly beneficial. College expenses often span four or more years, and ongoing contributions can help manage these costs more effectively. By continuing to save, you can reduce the need for student loans and the interest that comes with them. Even modest contributions can grow and provide additional funds for tuition, books or other qualified expenses, easing the financial burden over time.

Overestimating Tax Penalties

Fear of tax penalties often paralyzes people when making decisions about their 529 plan. While it’s true that non-qualified withdrawals are subject to taxes and a 10% penalty on earnings, this fear should not overshadow the substantial benefits of the plan. Qualified withdrawals for educational expenses are tax-free, providing a significant advantage. Additionally, understanding the exceptions to the penalty, such as for scholarships or military academy attendance, can alleviate concerns. Focus on the long-term benefits and plan your contributions and withdrawals carefully to maximize the plan's advantages without incurring unnecessary penalties.

Misunderstanding Withdrawal Guidelines

Misunderstanding or ignoring the rules governing withdrawals from a 529 plan can result in unwanted penalties and taxes. It is crucial to ensure that withdrawals match qualified education expenses in the same tax year. Qualified expenses include tuition, fees, books, supplies, equipment, and room and board if the student is enrolled at least half-time. Keep detailed records of all education-related costs to provide proof if needed. Be aware that expenses like transportation, health insurance and student loan payments are generally not considered qualified. Proper timing and documenting your withdrawals can help you avoid unnecessary complications.

Neglecting Retirement Savings

While it's commendable to prioritize your child’s education, doing so at the expense of your retirement savings can jeopardize your financial future. Remember, there are numerous ways to finance a college education, including scholarships, grants and student loans. However, there are no loans available for retirement. Striking a balance between saving for college and saving for retirement is essential. Consider working with a financial advisor to create a comprehensive plan that addresses both goals. By ensuring you are on track for retirement, you can avoid becoming financially dependent on your children later in life.

By avoiding these seven common mistakes, you may better maximize the benefits of your 529 savings plan, ensuring it effectively supports your child’s educational goals without compromising your financial health. Start early, save often, stay engaged and stick with the program. As I mentioned earlier, we have had many students close to us to celebrate this summer. To see the looks on their parents' faces and understand the family priorities and revel in their successes is priceless. Our friends and family are proud of our kids, and we are quietly proud of the job we have done. The joy associated with sending them on to the next chapter of their lives without a pile of debt is a blessing and provides hope for a bright, successful future.

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Authored By: Rob Armstrong

Inspired By: The Class of 2024

Tax/Legal Advice Disclosure

NOTE - Although the firm provides general information about the impact of taxes on various investment categories and the potential impact on estate and financial planning, Summit is neither a tax or legal advisor.