529 College Savings Plan Explained

Let's get right into how it works. So these dollars get invested after-tax into an investment account that grows tax-deferred. And if they're used for college education or K-12, they come out tax-free.

The 529 college savings plan vs. Roth IRA

When you're thinking of the 529 plans, think of them just like a Roth IRA. These contributions are after-tax dollars, the same as the Roth IRA. They're going to grow tax-deferred, and then they're going to come out tax-free as long as they're used for a qualified expense. The Roth IRA is for retirement; the 529 plan will be for college education expenses. And again, when I say college education expenses, I'm also talking about K-12.  There are minor differences but pretty close and appears to be constantly changing. For any of those school-related expenses, you can use a 529 plan.

The 529 plans are set up state by state. That doesn't mean you're limited only to your state's 529 plan. You can look at other states to see if they have a better 529 plan.

529 Plan Investments

When you're looking at a better 529 plan, the investments are arguably the most critical part of the plan. So the investment choices inside these 529 plans are typically mutual fund type of investments, and you'll be able to choose some of the options inside those plans. So you kind of construction on the portfolio. There are also portfolios designed with a specific target date in mind. When comparing the 529 plans, it will come down to the investment choices inside that plan, which traditionally are mutual fund-style investments.

Now some of them allow you to construct a custom portfolio. So if you want to get into the weeds of it, you can build a portfolio or choose a target date style fund, which will either show you your child's age or the target on which the money will be used. So those are target-date funds.

The idea behind them is they're going to be a mix of equities or stocks and bonds. The closer we get to that target date, it will have more bonds than equities in that plan, which will gear it towards their risk tolerance for that particular goal.

529 Plans and multiple beneficiaries (kids)

Another point of the 529 plan is the ability to transfer to another beneficiary. Suppose you have multiple kids, and your oldest is in school, and they don't use all the money. You can trickle that down to another beneficiary or give it to another family member, niece, or nephew.

There's a lot of flexibility in transferring the 529 plans. And if you have multiple kids in school simultaneously and have twins or triplets, you can take that money in specific plans and transfer it in the same year. So you don't necessarily need to have multiple 529 plans or multiple accounts when you're planning.

You can have those assets in a 529 plan and then transfer them to another 529 plan. You can't have two beneficiaries on the same 529 plan or pay for two beneficiaries with the same plan. You will eventually have to open up a separate 529 plan account. And those rules are based on the individual plan. So be sure to check with whatever plan you're going with on their transfer rules.

I know for the state of Florida, you can take the assets from the 529 plan and transfer it into another 529 plan with the state of Florida as many times as you want throughout the year.

529 College Savings Plan Funding

The amount funded into a 529 plan depends on the plan, but it's way higher than the school's cost.  So there's no actual number on it. But if you don't use those dollars for college education, you will have income taxes, but then you're also going to have a 10% penalty on the growth. So you don't want to overfund the 529 savings plans with the idea it's tax-deferred, and you can pay the taxes later. And you also want to consider the gift tax consequences currently in 2018, that's $15,000 per beneficiary.  There are ways around the gift tax, but that's for another post or video.

You might want to spread out your contributions over many years when planning a college education. One of the most significant risks of the 529 savings plans is the bond funds inside these plans. And a lot of these target-date funds will shift more into bonds or bond funds, specifically in these plans to make you believe that they're being more conservative in their investments and that money will be there.

But bond funds can lose money and positions, such as bonds, which adds another layer of risk when looking at a bond fund versus that individual bond. It's such a big deal. I'm going to do another video to explain and give you some data to back it up on what you should look at when looking at these 529 plans and whether it is worth investing in a 529 savings plan.

We can get a little more in-depth on the 529 savings plan investment portion and the risks that are not discussed enough in a 529 savings plan.