Financial Advice I’d Give My Younger Self: Planning for Education Financing

At the end of most talks I give, the moderator often asks, “What else does our audience need to know?” I always look at the younger members in the room or on screen and think: if only I knew this when I was your age.

While my business is to provide financial and estate planning advice to clients who have already accumulated a significant amount of wealth, there are many fundamental planning strategies that apply to those just beginning their careers, things that I would frankly like to know when I was growing up. So, I’m writing this four-part series on planning tips I’d give to my younger self. Topics will range from planning for college savings, young families, retirement to caring for aging parents. This first article focuses on college savings planning.

Saving for college is often viewed from the perspective of the parent saving for the child, and if you’re one of the lucky ones whose parents can afford to have done it for you, good for you. However, saving for college, or more appropriately saving for education, is not a domain strictly reserved for parents and children. As a young adult, you can start thinking about saving for higher education and how to do it tax-efficiently. Specifically, I am referring to a 529 college savings plan and a Roth Individual Retirement Account (IRA).

529 college savings plans aren’t just for kids

The 529 College Savings Plan is a tax-advantaged vehicle designed to save for education. The money held within these accounts can grow income tax deferred, and when the money is eventually distributed for use for qualified education expenses, it will also be income tax free. In other words, earnings and appreciation on investments held in a 529 account can be completely free of income taxes if used for educational needs.

For many, the first experience with a 529 account is when a young parent opens one for a newborn child; that was certainly the case for me, as my first 529 account was opened for my son a few months after his birth. Here’s the tip I wish I’d known years earlier: you can open an account for yourself. Instead of putting your extra savings early in your career into a savings or investment account where the interest and growth would be taxed, consider putting those savings into a 529 account for your own benefit. If you go to graduate school, you can use that money to pay for tuition, books, and room and board. As with any tax-advantaged account, the value of compounding growth free of income taxes can be a nice boost to the bottom line. In addition, certain states also offer a tax deduction or credit on contributions to a 529 account.

You might be wondering: what if I don’t go to graduate school or receive outside funding like a scholarship? Money from a 529 plan can still be withdrawn for any use (i.e., non-educational use), but the withdrawal will be subject to income tax at the time of distribution and a 10% penalty if not used for expenses. of qualified education. Even so, you may come out ahead, because depending on the growth of the investment and how long the 529 account has been open, the value of the income tax-free compounded growth over the years may exceed the tax and the penalty imposed for taking a non-qualified withdrawal.

What is more likely, and where the long view comes in, is to think of the 529 account as a tax-advantaged vehicle not just for its education, but any loved one education. You can change the name of the beneficiary of a 529 account to a qualifying family member (for example, another child, niece, nephew, in-laws), which means that if you ultimately don’t need the money for your own educational needs, you can effectively “”transfer” those funds to someone else for their own education, all while earning the same income tax benefits.

In hindsight, not only should I have opened a 529 account for my own law school education, but I should have continued to contribute to the account and “roll over” it to my son when he was born as the new beneficiary. If I had done that, I would have boosted my son’s college savings with a good 15 years of compounded tax-free growth.

Roth IRAs aren’t just for retirement

Another tax-advantaged vehicle that can be used to save for education is a Roth IRA. These accounts are often considered for retirement purposes, which is how they are primarily used. The advice I would give to my younger self is to consider using this strategy to finance education as well and not just for retirement.

Similar to a 529 plan, earnings and appreciation earned on investments held in a Roth IRA are income tax deferred, with the potential to ultimately become tax-free. Contributions you make to a Roth IRA can be accessed at any time without taxes or penalties. Plus, when earnings and growth are distributed outside of the Roth IRA, it’s also income tax-free (as long as it’s a qualified distribution, more on that in a bit), regardless of use.

The Internal Revenue Service (IRS) also provides a penalty feefree distribution from the Roth IRA to pay higher education expenses for you, your spouse, children, or grandchildren, as long as the distribution does not exceed expenses for the year. Of course, if the assets are ultimately not needed for education, the Roth IRA can be used for retirement.

There are some key differences between 529 plans and Roth IRAs that should be considered when planning to use either for education savings purposes. The first is in time. Although you can make a distribution from a Roth IRA at any time, there will be a 10% early withdrawal penalty if the distribution was made before age 59½, unless an exception applies. If a distribution was made within the first five years after a contribution to a Roth IRA, income tax will also be imposed at that time on the earnings (withdrawal of principal is income tax-free). Therefore, the Roth IRA is likely to be best viewed as a savings strategy for a child’s education when you withdraw after the five-year period from first contribution and after age 59 1/2 (of course , is also available if one was to obtain higher education at a later age).

Another critical difference is in the income limits. To qualify for contributions to a Roth IRA, income must be below a certain threshold. In 2022, that threshold is $144,000 for single people and $214,000 for married people filing jointly. A 529 plan, on the other hand, has no income limitations, so one can make contributions regardless of income level. Therefore, one must take into account one’s earning potential, because if your earnings start to exceed the set limit amount, the Roth IRA strategy may not be available.

Of course, these two strategies are not mutually exclusive and if there are enough excess savings, you can always contribute both to a 529 plan. Y a Roth IRA.

When considering which option is right for you, there are many other factors that are beyond the scope of this article, such as:

  • Investment options offered by the plan: 529 college savings plans may offer different investment options compared to Roth plans and may generally be more limited.
  • Contribution limits: If you’re under 50, you can only contribute up to $6,000 per year to a Roth IRA for 2022. With 529 plans, meanwhile, there are no limits, though gift taxes could come into play when contributions exceed $30,000. per couple per year.
  • Impact on financial aid: Income eligibility and qualification varies between 529 and Roth and will depend on many factors, including time and ownership.

While you should always consider consulting with a financial advisor before making a final decision, I wish I’d even known to ask the question when I was younger.

Hope this was helpful, and stay tuned for next month’s column: Financial Advice I’d Give to My Younger Self: Planning for a Young Family.

Wilmington Trust is a registered service mark used in connection with various trust and non-trust services offered by certain subsidiaries of M&T Bank Corporation. Wilmington Trust Emerald Family Office & Advisory is a service mark and refers to the estate planning, family office, specialized transactions, and other services provided by Wilmington Trust, NA, a member of the M&T family.
Please note that tax, estate planning, investment and financial strategies require consideration of the suitability of the individual, business or investor, and there is no guarantee that any strategy will be successful. Wilmington Trust is not authorized and does not provide legal, accounting or tax advice. Our advice and recommendations provided to you are illustrative only and are subject to the opinions and advice of your own attorney, tax advisor or other professional advisor. Investing involves risks and may result in profit or loss. There is no guarantee that any investment strategy will be successful.

Chief Wealth Strategist, Wilmington Trust

Alvina Lo is responsible for family office and strategic wealth planning at Wilmington Trust, part of M&T Bank. Alvina previously worked at Citi Private Bank, Credit Suisse Private Wealth, and was a practicing attorney at Milbank, Tweed, Hadley & McCloy, LLC. She has a bachelor’s degree in civil engineering from the University of Virginia and a juris doctorate from the University of Pennsylvania. She is a published author, frequent speaker, and has been quoted in major outlets such as “The New York Times.”

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