There seems to be a lot of heated debates in personal finance. Like Roth vs. Traditional retirement accounts. Because 529 plans are a savings vehicle for college, they seem to get a bad rap in the FIRE branch of the personal finance world. Like first of all, you’re dumb for having kids. And secondly, you’re double dumb for not having them become a plumber. In fact, a lot of my friends suggest not touching 529 plans until you’re maxing out all retirement accounts (Hi Angela !).
I’ve been a little loathe to talk about the fact that we have 529 plans for our kids and are actively saving for their college education. But after a reader comment on how we save our money, I thought I needed to write a post about why we have 529 plans for our kids (but also why we’re not saving an astronomical amount in them).
What is a 529 plan
A 529 plan is like a Roth IRA that can be used for qualified education expenses. You put in post-tax dollars and they can grow tax free. Assuming your child attends college, you can make tax free withdrawals for qualified education expenses.
As the parent, you “own” the assets in the account a list a beneficiary (your college bound child). If your child doesn’t go to college, you can switch the beneficiary to someone else in your family and still make qualified tax-free withdrawals. Furthermore, you can use the 529 to pay for graduate school or pay off student loans. So even if your kid doesn’t go to college, you can still find plenty of ways to use the tax-advantaged money.
529 plans have some advantages when determining the “expected family contribution” for college through the FAFSA form. My friend Seonwoo wrote a really detailed analysis of this. You should just read what he wrote (Unfortunately he took that website down).
Finally, it’s always possible to get money out of the 529 plan and back into a taxable account. In this case, you’d pay tax on the capital gains in the account plus a 10% penalty.
Why wouldn’t you want to have a 529 plan for your kids?
For a community that loves taking advantage of tax advantage accounts, the personal finance community seems to have a phobia of 529 plans. The main argument is that 529 plans are too restrictive. It’s an account that can only be used for educational expenses!? What happens if your kid doesn’t go to college? What if they get a full ride scholarship because they are awesome at tennis? Or What if I decide I don’t want to help them pay for college at all so they can pull themselves up by their bootstraps like I did?
Well here’s another what-if… What if they do decide to go to college? And what if by putting a few dollars away ever week you could help them start with less crippling student loan debt?
The FI/FIRE community emphasizes putting your financial well-being first, before helping others. (The so called plane-crash “oxygen mask” theory.) I get that. But anyone working towards FI in many ways already has their oxygen mask on— 40% of Americans have less than $400 in savings. I feel if I’m working towards saving millions of dollars to retire early, I should be able to put at least a *something* away at the same time for my kids.
Why we have 529 plans for our kids
We have 529 plans for our kids because we think it’s likely that at least one of the kids will go to college. Furthermore, we will be in a situation to help them pay for college. (Although we are still going to be like the Financial Mechanic’s parents and crush any designer college dreams). The 529 plan allows us to set aside some money today for this future planned expense. And the way the 529 plan is structured, we are able to do so in a tax efficient manner.
Because our state has one of the highest state income tax rates, it is especially advantageous to use our 529 savings plan. We immediately get a 6% return on our investment because we get our state taxes refunded on contributions. It’s hard to beat that risk-free instant return on investment through alternative investment vehicles.
In the beginning, we wanted to save enough for 50% of GovTween’s college expenses at a state university. But then life happened. We moved. Then we had more kids and daycare expenses. We also got promoted. It seemed like every 6 months our whole financial picture changed. Every up or down on our path changed our contributions to our retirement accounts and 529s.
How our 529 plan strategy changed after pursuing FIRE
When we found out about the FIRE movement, all of our savings plans changed. We weren’t saving for some distant retirement in our 50s, but instead an imminent departure from the workforce. We currently save very little in our 529 plans.
We still hope to give each child enough money for approximately half of the cost of college (at our state university) if they choose to attend. However, pursuing FIRE has given us more options.
- We will have our house paid off before they start college. If we are still working when they attend college, we will have a lot of extra income floating around that we could help them pay as they go.
- Furthermore, since we save a large percentage of our income, we could adjust our savings at any time to put away more money for college if we feel we need to save more. This may delay our “RE” date of FIRE, but is still an important part of achieving our financial goals.
- Conversely if we have enough money to retire early before the kids start college, we could then start aggressively saving for their college before exiting the workforce.
- Finally, if we retire early, our income will be much lower. While the FAFSA tests both income and assets in determining the expected family contribution, it primarily looks at income. By retiring early, it may affect our children’s ability to receive financial aide.
In short, pursuing the financial independence part of FIRE has given us a lot of options. Not just early retirement options. But options in how to help our kids work towards financial independence. Earlier on in our kids lives, we leaned more heavily on 529 plans. That money is still growing tax-free and will likely be withdrawn tax free. While we aren’t saving a lot now in their 529 plans, I’m glad that money is already there.
Still Undecided- here are what some of my other blogger friends had to say on the topic:
- I Finally Opened A 529 Account! by Stephanie
- It’s Perfectly Fine to Put Off College Savings by Brave Saver