College or Retirement: Does a 529 Plan Make Sense?

Maybe there’s a better way to accomplish both!

Jim Lorenzen, CFP®, AIF®

Can’t afford to save for retirement because you need to accumulate money for your kids’ college expenses?   Sound familiar?

Most parents are willing to put their kids’ education ahead of their own retirement needs, according to a T. Rowe Price survey.   In fact, their research says it’s true of 74% of parents – all willing to prioritize college saving over their own retirement needs.

But, is that the smart thing to do?

529 plans tend to be the primary college savings vehicle, but parents could be, and often are, jeopardizing their own financial security.  529 plan do offer tax breaks for their depositors; but those tend to be low dollar amounts and then often limited to only state income taxes.   A 401(k) or IRA can cut their federal taxes up to 40% for every dollar they deposit!  –  And, it’s even more if the parent’s employer is matching contributions!  This isn’t rocket science.

As for investment choices, 401(k) and IRA menus still tend to offer greater flexibility and access to thousands of mutual funds, ETFs, even individual stocks, bonds, and certificates of deposit.

 The Liquidity Issue

While 529 plan assets can be withdrawn at any time, if it turns out you have no qualified higher education expenses to match the withdrawal amount, the earnings can be taxable income – and there could be an additional 10% penalty on the income portion.

There are, however, ways to tap retirement accounts with minimal impact from taxes, costs, or penalties:   You might be able to borrow from your retirement plan at work – maybe with no application and at low interest rates – and Roth IRAs allow withdrawals of contributions at any time for any reason with no taxes or penalties.  Earnings can be withdrawn after age 59-1/2 without taxes or penalties, as well.   Note:  Those under age 59-1/2 will be taxed on the earnings portion of a Roth IRA, or any part of a traditional IRA, as regular income.  However, a pre-59-1/2 IRA or Roth IRA owner may avoid the 10% penalty if the money is used for qualified higher education expenses.

Caution:  It’s worth noting that any distribution from a parent’s retirement account may be counted as income when calculating subsequent years’ financial aid and may reduce any needs-based benefits.

Speaking of needs-based awards and benefits, while no more than 5.64% of 529 plan account value will be considered each year before any needs-based money is awarded, retirement account assets usually aren’t counted at all!

Retirement should be your number one priority.  Structured properly, retirement funds can be arranged to provide solutions for multiple objectives and minimize Uncle Sam’s dip into your wallet, as well.

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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.