Dear Mrs. MoneyPeace: My daughter just turned 3 years old. All the uncertainties of 2020 are making me rethink my future financial plans for her. After he was born I wanted to establish a 529 plan. But, surprise, as a single mother, I never did. As we head into 2021 with all this talk about debilitating college loan debt, I started to wonder if it still makes sense to start a new 529 plan or just keep contributing to my current 403 (b) retirement account. and then tap early for her, if necessary.
I don’t know if my 3 year old daughter will go to college, so would saving through my retirement account be more flexible than starting a 529 plan?
I am a 17 year veteran teacher in the California Bay Area. I plan to retire early (57ish) with 30 years of teaching under my belt. I will already have a CalSTRS guaranteed pension but have saved about $ 25,000 off of that in a 403 (b), as a hard day fund. I plan to contribute very modestly to that account and I guess I’ll have it between $ 50,000 and $ 60,000 by the time I retire. Since I will already be separated from work, I have the impression that I can take advantage of it before the age of 59½. If this is the case then I could withdraw whatever is necessary for college related fees to support my daughter. My guess is that if you go to college, you will get a part-time job and take out minimal loans. My fear in setting up a new 529 plan is that despite all my years in education and being a pro-college parent, my daughter may not want to go the traditional college route. Then I would be stuck with this 529, with no relatives to pass it on to, as their children are already well cared for. What you think? I’m exaggerating? Sincerely, Fear of the Future Mom Dear FOTFM, You are understandably confused by all the uncertainties surrounding college funding. Balancing is the best way to approach important financial decisions, especially when there are so many unknowns. Different goals (retirement, a child’s education, saving for an emergency) have different time horizons and funds should not be mixed. A cornerstone of good financial health is having money in a savings account to draw on. Your 403 (b) investment is not an emergency fund. If you have one, great. If not, start saving now with a goal of three to six months of living expenses. A 529 plan is an investment vehicle for college, starting in as little as 14 years for you. That’s a much shorter time horizon, and therefore you need a different investment strategy than a retirement account. Why start a 529 plan now? Increased likelihood of attending college. Children with even young college savings plans have higher college attendance rates and are more likely to graduate from college than those without savings. Don’t underestimate the positive psychological effects of starting a college savings plan early in a child’s life. This motivates kids academically and socially for college from a young age, so let him know that part of his next birthday gift will go toward savings for college. Flexibility. The rules have changed in recent years. Because you can now use 529 for private college education, other classes such as technical college, books, and room and board, as well as college tuition, you and your child are not locked into a four-year college. Most careers need some advanced education, so your daughter will receive support however continue with her education. Tax-free earnings. The funds are invested in mutual funds and grow free of state and federal taxes. A 529 plan is funded with after-tax money, and withdrawals to pay for school expenses are not taxed at all. More than 30 states have a tax deduction for contributing to a 529 plan. Currently, California is not one of those (attempts to add such a tax relief have failed to date in the state legislature), but a 529 still has more. make sense to save in any other way. So start contributing now, even $ 25 or $ 50 per paycheck, and get ready for your daughter’s education. Starting small is a reasonable way to establish a good habit, even with all the other expenses you face. Read: These are 3 big mistakes you can make with a 529 plan. It is wise for your daughter to commit to minimal and working loans. Just be realistic about how much your daughter can work in college without affecting her school work and how much of the costs those earnings can cover. Tuition and textbooks cost much more than in school, and overall college costs have risen faster than minimum wage. Read: It’s almost impossible to make your way into school. If that 529 plan is never used to pay for your child’s college education, the money is still yours. You can use it for education yourself or someone else in your household or withdraw the money for other purposes. If it is not used for education, you will have to pay taxes along with a 10% tax penalty on earnings only, as opposed to the taxes and penalties owed for an early withdrawal from retirement accounts. If you give it to your daughter for another purpose, she will pay taxes, and it will most likely be a lower tax bracket than yours. As for taking advantage of your retirement plan at age 55, you can be one of those who qualify to do so without penalty. Those who do not pay a 10% penalty before 59 1/2. You will still have to pay federal income taxes and possibly state income taxes as well, even if you are retired. The fiscal impact leaves less for your daughter’s education. Read: Here’s how you can retire from your 401 (k) at age 55, without paying a penalty Even with your pension, funding an IRA, 401 (k), or 403 (b) is still wise. You could easily live to be 90, so maybe 35 years past your planned retirement date. Inflation and health problems could erode the pension. Extra money may be needed. So keep putting money in your 403 (b), lower your taxes today, and give more when you retire. Don’t use that money for non-retirement expenses, including college costs, even if you’ve retired early. Remember, you are planning for college expenses 14 years from now. At that point, you may have a job you like within the California education system. Or you can work somewhere that helps you with your daughter’s tuition. Or you can choose a different educational path. Or part of the university could be funded by the federal government. We just don’t know. Instead of acting like you know the outcome, fund your accounts with a purpose today. In the long run, you will be better prepared for what comes up. This integrated financial wellness strategy will serve you and your daughter. CD Moriarty, CFP, is a MarketWatch columnist and personal finance speaker, writer, and coach. She blogs at MoneyPeace. Email your questions to MsMoneyPeaceQuestions@MoneyPeace.com More from MarketWatch on Planning for College Spending To get the most college financial aid for your child, follow these steps during sophomore year of high school 4 Key Lessons That parents of high school students should learn about planning for college How to Use a Moneyball Strategy for College Applications and Find Great Schools That Are Undervalued The Number One Job in America Paying $ 100,000 a Year – Not in Silicon Valley