Real Life Planning Episode 49- How 529 Plans Can Help You Save for College and Reduce Your Tax Bill
Financial PlanningIn this episode, Vekevia Tillman-Jones jumps into one of the biggest financial concerns for parents—how to afford the rising cost of college. She breaks down how 529 plans work, the tax benefits, and what to do if your child doesn’t end up using the funds for higher education.
"You will never pay tax on all of that growth as long as when you pull the money out, it’s for qualified education expenses. That’s a very big deal." - Vekevia Tillman-Jones
This week on Real Life Planning Podcast:
| 💡 | How much does college really cost today, and how fast are prices rising? [00:01:20] |
| 💡 | What makes a 529 plan such a powerful savings tool? [00:09:30] |
| 💡 | What expenses qualify (and which don’t) when using 529 funds? [00:15:10] |
| 💡 | What are your options if your child doesn’t go to college? [00:20:35] |
| 💡 | How can you use 529 funds for K-12 tuition, student loans, or even a Roth IRA? [00:25:50] |
| 💡 | What are the best ways to get started with a 529 plan? [00:30:15] |
Connect with Real Life Planning:
Takeaway Quotes:
"If you have something growing at 6 or 7 percent a year and your savings account is earning 0.2 percent, that’s a big problem." -Vekevia Tillman-Jones
"The 529 plan allows you to invest, grow your money tax-free, and withdraw it tax-free for education—this is huge!" -Vekevia Tillman-JonesAbout the Real Life Planning Podcast
Hosts Cynthia Meyer and Vekevia Tillman-Jones explore practical steps for real estate investors to build financial freedom and make working for someone else optional.
Transcript for Episode 49
[00:00:00] Financial planning is all about managing your expenses and a very high expense that clients always bring up is just, if I want to send my kids to college, it's a very expensive, bill. And I don't even know if they're going to go to college, but I'm trying to say towards it or think about what's the best way to be prepared for that bill. And a lot of times they think about a 529 plan and then they just have questions they want to know doesn't even make sense. I think it's important for clients to bring that up really, because if you think about it, the cost of college is so expensive. In fact, the cost of a four year in-state public school for tuition and fees is about $11,000.
[00:00:42] Now, this can vary, right? If we look at different states, right? But just on average, tuition and fees is about 11,000 for in-state four year public school. Now, if your child decides that they want to live on campus, and then they likely might need a meal plan, you can stick at another $13,000 about to that. So, you're looking at $24,000, and that's if they chose to stay in state.
[00:01:08] Obviously the cost of a private school education is going to be significantly higher. In fact, if they just wanted to go to a different state, you could almost double those figures. And then for private school, you could almost triple them.
[00:01:19] Right? So in some schools are going to be much higher than another private school. So those are all really important to consider. And so when you think about that, what you're essentially trying to do is think now for this astronomical figure that we're talking in today's dollars and not even perhaps when the kid needs to go to school 10 plus years down the road, right? Especially if you're starting to say early.
[00:01:42] So you have a number of things that you're trying to solve for. You're trying to think about what if they don't even go to school? Now what? Did that ever make any sense? So I think all of these are important. What I tended to mention to clients is we're trying to solve for a number of things.
[00:01:57] One, we're trying to solve for inflation, right? And the cost that this expense is going to be or grows each year and we have to keep up with that. So on average, the cost of education tends to grow anywhere at 6, 7 percent a year is what we average oftentimes when we're trying to just engage that for financial planning purposes.
[00:02:19] And so if you have something growing at 6 or 7 percent and you haven't planned for it, that's very difficult, especially if you think you're just going to pull out of a regular savings or just keep adding to regular savings, making 0. 2 percent or so or 0. 01 percent even. That's not going to keep up with the way or the pace at which that expense is growing. So that's something to think about. So number 1 is you need to park that money somewhere.
[00:02:45] Number 2 is you want to make sure that it's growing. And number 3 is on all that growth, we know usually there's some type of taxation. So how do I even deal with the taxes on that? And then how do I make sure I've benefit when it's time to pull out the money? So those are some of the just larger pieces to think about when we consider saving for college.
[00:03:05] A 529 plan can be very advantageous for a number of reasons.
[00:03:09] Number one is it is a way to take money that you've earned. So you got paid, you've already paid taxes on that money, and now you can take this money and put it into a 529 account. And we'll talk more about what happens after that, but you put this money into a 529 account. And then the money that you put in that account, you invested either on your own or it's in a various plans and that's being done for you. And then that money is going to be growing. So it's how it has earnings, right? So there's this growth over time. And what the 529 plan allows, one of the benefits that it allows is that those earnings, you will not pay tax on that money every year while you're earning it. Right? And as long as you use those funds in the future, when your kids go to college to actually pay for qualified education expenses like tuition costs, or even housing, those types of things, books, as long as you use those funds for qualified education expenses, you will- in fact never pay any tax on all of that growth, which is huge. So let me say it again. You will never pay tax on all of that growth as long as when you pull the money out is for qualified education expenses. That's a very big deal.
[00:04:34] So now there is an exception to being able to pull those funds out prior to and the fact is if you're paying for K through 12 expenses, you'd be able to pull out up to currently $10,000 each year to pay for little Johnny or whoever to go to private school or for K through 12 expenses. That's something to think about as well.
[00:04:58] Now there, a lot of times people are like do you get any type of deduction for putting money into there? So you do not get a federal tax deduction for putting money into a 529 plan. However, there are some states where they do allow for a state income tax deduction. So you can put money into that account. However much that you're contributing, and that amount would be from the amount that you put in, you will be able to take a deduction for that amount for the year. Now, that amount that you're allowed to deduct vary state by state. So it doesn't mean that it'll minimize or limit rather the contribution that you could have, but they may actually put a limit to how much you're able to deduct in that vary state by state. You have to state check with your particular state to see what the rules and regulations are for that. So no deduction at the federal level, but the state level, there could be a state deduction. Now, there are some states like Florida where there is no income tax. So, thus, there is no deduction either.
[00:06:02] So that's just something to be aware of as well. If you don't have any state income tax deduction, then you're likely not going to be able to take any type of deduction on a contribution that you make to that part 29 plan.
[00:06:12] Naturally, the next question could be how much can I contribute or how much should I contribute? In terms of how much you can contribute, there is not actually a maximum contribution amount per se that is technically tied to a 529 plan. Now, there are some states that will have their own limit to how much anyone can put into a 529 plan within that state for one beneficiary- for a single beneficiary.
[00:06:44] So if you were to let's say if that was I think California is like 200 and something thousand, maybe $243,000. So let's say if you hit that limit for your child Joshua, and that means that for any other 529 funds that you want to contribute for Joshua, it could not be within the 529 plan within the state of California, if you've already hit that threshold. You could go to another state and have another 529 plan. If you were comparing the 529 plan, for instance, to like an IRA, those have certain contribution limits each year where this 529 plan does not have that. Something else to consider is just if you want to avoid any type of, having this reported and gift tax, those kinds of situations you can put in up to $19,000 for 2025.
[00:07:35] It was $18,000 for 2024, but you can put up to $19,000 in that account and where this comes into play is if someone is saying, you what, Vekevia, maybe I just want to put one lump sum and be done with this. So they could either run the numbers and come up with what dollar amount makes the most sense for them as a lump sum to hit their goals.
[00:07:56] But also they might say what I can put- I can front load this, which essentially allows you to super fund the account, so that $19,000 mark where you wouldn't have to worry about reporting for gift tax is essentially- you could take that $19,000, multiply that over 5 years. They allow you to super fund it for 5 years and then you would essentially be able to put that, what, 90 or so thousand, I think I did a calculation, yeah, $95,000 into that 529 plan. Now that's for a single person. So if you're married filing jointly, you can double that, right?
[00:08:34] So $190,000. You could do that lump sum as well, and then you could just be done with it and it would stay invested and then you would not have to worry about any further contributions. If that is what the figure is that was needed to hit your particular goal.
[00:08:49] What expenses actually are considered qualified expenses? So if you think about it, it's going to be think tuition and fees for university, college, trade school, or even K through 12 education, public or private school. If you have to pay tuition and fees there. Other things that will be included is if you had to pay for a meal plan, books, supplies. Now, what's important about books though, is for books that are required for your class. So if there was just like other books that you think could be helpful, but they're not necessarily required by class. That is not considered a qualified expense. So when you look at the unqualified expense side of that, so, transportation costs. You can't rent a car or the cost of a car so that you can get to and from school and class. It's not going to be a qualified expense. Also, any cost that you incur before you actually get to enrolled in attending school, so application fees or anything like that or any testing fees. That would not be considered qualified expense. The cost of health care is not going to be a qualified expense. So it's just very important to know, yes, you can invest in the 529 account. Their earnings can grow over time. You will not owe tax on those- any of that growth as long as you use it for qualified education expenses. It's very important just to remember and know that running list the irs.gov, as well as savingforcollege.com are 2 great resources just to stay on top of- okay, what expenses are included as qualified or considered qualified and which aren't.
[00:10:23] Another question that could come up is what if my child doesn't use the funds or what if I pull the money out for non qualified education expenses? If you pull the money out for non qualified education expenses, whatever the reason might be, essentially, think about the fact that the money that you put into the account is made up of two different buckets.
[00:10:44] One bucket is money you were paid, you already paid taxes- income taxes on that money, and then you put it into the account. The other part of that bucket is the money that you put in the account has been earning, it's been growing. So there are earnings on those invested dollars. The money was put in there was invested and then you have earnings.
[00:11:02] So you have the money that you were paid. Okay. You put into the account, you already paid tax on that anyway and then their growth or your earnings in the account. So if you pull the money out for a non qualified expense, you would be subject to income tax and also a penalty. Now that does not apply to the portion or any funds that come from the money that you put in after tax anyway. So every withdrawal is going to have a percentage of the money that you had already put in and paid taxes on, and then those earnings. So any tax and penalty that I'm talking about is only on the earnings portion.
[00:11:40] So you will be subject to income tax, right? Because you never paid income tax. You had growth on that money. You never pay any type of tax on those earnings. So that will be added to your taxable income. And then you also have, at the federal level, a 10 percent penalty on those earnings portion of that withdrawal. Another thing that can come into play is the fact that some states actually impose or add on another penalty for non qualified withdrawals. California, for instance, is about 2.53% or just under 3 percent for California. If you, or someone who resides in California would be on those earnings, you'd have your income tax, your 10 percent federal penalty, as well as the state imposed or California imposed penalty. So that's something to consider.
[00:12:30] If your child does not go to college, you could, in essence, or, for whatever reason, even before that, you could pull the money out and you'd be subject to those- to the income tax and the penalties at the federal and maybe even at the state level, but are there other options as well?
[00:12:49] It also depends on why you had to pull it out. Maybe your child got a scholarship or and they just didn't need the funds. So then the penalty would be waived. You'd still owe the income tax on those earnings, but you wouldn't have the penalty. Now, as far as at the federal level, as far as the state level, you still want to check with your state, perhaps saying.
[00:13:10] We'll honor that, or perhaps it's not each state can be different. So you might check on that. But you could also just change a beneficiary. Perhaps you have more than 1 child, or maybe you want another family member or grandkids, or perhaps you could just change the beneficiary on the account. That's another way to get around it. And then now those funds can be used for someone else's education. Something to think about. But the 529 plan overall can be very advantageous. You get to put that money in, essentially defer putting off any tax on any of those earnings and either up until a certain point that you pull out for non qualified expenses or the point that they use it for qualified expenses. You would have deferred it forever. You will never pay any type of tax on those earnings. You don't want to make that decision in isolation of other options, but the 529 plan definitely have its has its benefits.
[00:14:06] What if you're trying to avoid maybe your child isn't going to go to college, at least for now, or you're not sure, and you want to avoid any tax or penalties, one option that you have is to maybe transfer those funds to your child's Roth IRA. Maybe they're older there. They've started working. They're eligible to actually contribute to a Roth IRA. You could transfer funds to that account. Now, there is a limit on that. You can do up to $35,000 dollars total over their lifetime from a 529 to a Roth IRA for their benefit. But the only thing is you couldn't do it all at once. So whatever the contribution limit is for the year, that's the most that you could transfer for that particular year to the child's or beneficiary's Roth IRA. So for 2025, for instance, that would be $7,000. And you could do that over the course of five years until you get to that $35,000 limit. Another thing that you could do is use those funds to help pay for any type of student loans that the child may have had and you can do up to $10,000 to pay for any student loans. So if they, took on 30,000, 40,000, you couldn't do the whole thing, but you can at least do a portion of it. So that's something else to consider.
[00:15:12] So after you think through all the various options, and if you decide that a 529 plan makes sense for you, there are a number of different ways that you can get started. Number one is you can go to your 529 plan for your state and look at the various state options that they have. You could also speak with your financial advisor, your financial planner, or go to a brokerage like Fidelity, for instance, and open up a 529 account and you can be as hands on or hands off with the investments as you like, you might be someone who wants to have a lot more say so in the types of investments that are in that account, or you might be someone that says, you know what I want to just put this particular money into an account that's just like similar to some target date funds for retirement accounts. It says my child is is going to go to college and let's just say 2050, for instance. And so I just want to set up a fund, put the money in a fund that's for target date of 2050 and what happens is it'll be a most aggressive in the earlier years. And then as it gets closer and closer to 2050, which is the date when the child will get ready to go to college, it'll become more and more conservative because you're not able to take on typically as much risk as you're getting closer to actually needing all those funds.
[00:16:24] But there are other ways to be invested in it as well. Some people might choose to stay aggressively invested. Perhaps they have other plans for those funds, or maybe it's going to be for more than one beneficiary over time and so it can be various options. You can work with a financial advisor who can help you figure out what makes the most sense.
[00:16:41] But a 529 plan is not the only option, but it is definitely one option that can be very beneficial if you understand how it works and you have a good idea about how much you want to put in and why and how long. As long as you have a purpose for the funds, it can certainly help overcome all of the many expenses that come along with college planning.
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