The cost of college is going nowhere but up, and young parents today, who are still paying off their own student loans, are worried. Saving for college in a tax-advantaged 529 plan is one way new parents are preparing.
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But personal finance expert and Instagram content creator Eryn Schultz (@her.personal.finance) is underfunding her kids’ college fund on purpose. Here’s why.
Schultz admits she went to a private college and had student loans. Her plan for her own children is to save enough for a public school in a 529 plan, but not to fund that account with enough for a pricier, private school.
Her reasoning?
“If I save for private school and my kid goes to public or decides to be a YouTube creator, we would owe taxes and a penalty on any money not used for qualified education expenses,” Schultz wrote.
The personal finance expert makes a valid point, and there could be even more scenarios where a child doesn’t use all of the money in their 529 account. A child could get an academic or athletic scholarship to college, or they could start at a community college and then transfer to a four-year school. Any of these scenarios could result in having money left in a 529 plan.
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A 529 college savings plan lets parents (or grandparents, or anyone, for that matter), save money for a child’s college education. The plan is funded with after-tax dollars, but the gains are tax-free if the money is used for college-related expenses, such as tuition, room and board, books, and supplies.
If the money is withdrawn for other purposes, as Schultz said, the gain in the account would be taxed and subject to a 10% penalty.
Schultz explains that she will save additional money for her kids’ college, just not in a 529 plan.
“I would rather save additional dollars outside of a 529 that can be used for a house down payment, a business or something else entirely,” she said.
This is valid reasoning, since you would not incur the 10% penalty if you withdrew these funds for something other than college. And because the gain on these assets would be taxed-as-you-go as capital gains, you wouldn’t have a big tax bill when you withdraw the funds.
As Schultz notes, there is a provision to roll unused 529 plan funds into a Roth IRA for the 529 beneficiary (the child). But there are restrictions.
