When I graduated from college, my parents gave me a stack of savings bonds. My aunts and uncles gave them in lieu of gifts for my birthdays and holidays. Some had been accruing interest since I was 1. Instead of long-forgotten toys, I had a few thousand dollars for rent, loan payments, and that first adult trip to Target. THANK YOU AUNTS AND UNCLES!
Before you jump to Amazon to buy your favorite newborn a plastic Sophie Giraffe, consider contributing to the 2019 version of a savings bond: a 529 plan.
what is a 529 plan?
First, a 529 plan is a tax-advantaged account that can be used for K-12 and college expenses. You pay federal taxes on the money you put into the account, but you don’t have to pay taxes on any growth or qualified withdrawals (e.g., taking money out to pay for college tuition). Plus, many states let you deduct the contributions from your state income taxes. Since they’re also flexible (you can change the beneficiary) and have a low impact on a child’s eligibility for Financial Aid, they’re a great option for paying for college, grad school, or vocational school.
why should you give to a 529 plan as a gift?
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The parents in your life are probably worried about paying for college. A 4-year private college in 2035 may cost over $206,000. ‘Nuf said.
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If the child doesn’t end up going to college, there’s flexibility to change the 529’s beneficiary. The money could go to a grandchild or sibling and can be used for vocational training as well. In the worst case none of those options work, a 529 can be converted to cash for a 10% penalty.
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YOU, the gift-giver, can deduct your gift from your state income taxes (assuming you live in state that taxes income). Can Goodnight Moon be deducted off your taxes? Didn’t think so.
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Why not give a savings bond like my Aunt Barb? Well, a US EE Savings Bond pays 0.1% per year and isn’t tax deductible. Many 529 plans (e.g., Ohio and Utah) have earned over 9% annually AND offer tax savings. Please note that past earnings don’t guarantee future returns and 529 plans have different returns.
how do you give to a 529 plan if you’re a friend, grandparent or aunt?
First, baby has to have one for you to contribute. Only 29% of parents have one. If these parent(s) are among the 71%, you can actually set it up for them (you will need to get the baby’s social security number, though). More on that below.
If they have a 529 plan already, then it’s easy! Ask the parent to send you a link to contribute to their 529. It takes 5 minutes and you can sign a nice personal note. Doesn’t this sound easier than swinging by Target on the way to the shower?
If they don’t have a 529 plan set up, you can offer to help, but, you will need the baby’s social security number, which may be a more comfortable thing to ask for if you’re a close relative.
If you are that close relative or a parent trying to set up a 529, first, you need to pick a plan. They are set up state-by-state but they are not all created equal and – YOU ARE NOT OBLIGATED TO USE THE PLAN FROM YOUR STATE. These are like any other investment accounts and different have returns and fees (read here for my ranting and raving 401Ks). The best advice for which to buy depends on where you live.
If you live in a state with no income tax OR a state which gives you a tax break for contributing to any 529 (Alaska, Arizona, Arkansas, Florida, Kansas, Minnesota, Missouri, Montana, Nevada, New Hampshire, Pennsylvania, South Dakota, Tennessee, Texas, Washington, and Wyoming), just pick the plan with the best returns/fees. I recommend CollegeBacker as an easy and simple option. CollegeBacker uses Utah’s 529 plan. The rating agency Morningstar has given it a gold rating for fees and performance the last 8 years. If you use this link to set up a CollegeBacker account, you’ll get an additional $25 toward your 529 plan!
If you live in California, Delaware, Hawaii, Kentucky, Maine, New Jersey, and North Carolina, you can also choose the 529 plan with the best returns/fees. In these states, you cannot deduct your 529 contributions from your state income tax. You can dig a little deeper and find some incentives state-by-state (e.g., the California plan will match your contribution if your income is under $75K). However, if you don’t qualify for one of these perks, CollegeBacker or another top-rated 529 plan are good options. Morningstar is a great resource to evaluate 529 plans.
If you live in any the BLUE states on the below map, set up a 529 through your state of residence. These states give a nice tax break for going through their plan. The numbers shown below are the estimated tax savings for staying in state (for a couple with $100,000 in taxable income contributing $200 / month or $2,400 / year across two children’s 529 plans). This number obviously scales for different incomes and contribution levels.
Some criticism of 529s
529s are structured to be loaded with riskier investment when the child is young and become more conservative as the child gets closer to college. In this way they’re like target date retirement funds. 529s have been criticized for having returns that are lower than directly investing in stocks, but like retirement, the lower return also comes with protection from a child having their fund get chewed up by a recession as he or she goes off to college.
Wrap
Taking a step back from the nuts and bolts of how to set up a 529, giving to college savings is better even than Sophie the Giraffe. Helping your favorite niece or god child save for college is less likely to make you the cool aunt or uncle today, but when they are getting ready to buy their first organic chemistry textbook, you can bet they will be grateful you gave them a financially savvy 1st birthday present.