College Savings--What if they don't go?

[disneymom3]

So, now that we are in a much better financial situation than we have been in before, we are getting set to work on the college savings for the kids. We have three and the middle one is not a traditional education kind of a kid. He is only six, but trust me, I can tell. I will not be at all surprised if he doesn't attend college--I think of my two nephews for instance who are in construction. One, at the age of 22 is running his own business and is very successful. The other one, not so much, but he is gainfully employed and has a lot of skills.

If you have, say a 529 and that child doesn't go to college, but say enters the police academy instead and becomes an officer (as this middle one has been saying for three years he wants to do,) what happens to that money?

 

[Mouse House Mama]

IT is so funny that you should be asking this! We are saving for our kids' future but we have decided against the 529 plan for just that reason. What if my kids don't want to go to college? Of course we want them to but we also realize that school isn't for everyone. We decided to just make out own investments for them. I am sure others will disagree but this works for us.

 

[OceanAnnie]

Julie, that's why we opted not to have a 529. That and it's a state thing. What if they want to go to an out of state college? You know what happens? You get hit with a big fat penalty! You pay.

So we're looking into other options. We're thinking mutual fund, CD, savings bonds, individual stocks. We'll probably do a varied approach. Haven't decided. For now, I withdraw the money we earn from Upromise and put it in their savings accounts. Once they have accumulated a bit we'll probably put it in a mutual fund. Mulling it over.

I do know we don't want to pay a penalty. So 529 is out for us.

 

[disneysteve]

http://www.savingforcollege.com/intro_to_529s/index.php?general_faq_id=5

Federal law imposes a 10% penalty on earnings for non-qualified distributions beginning in 2002. The penalty is not assessed on principal. An exception to the penalty can be claimed if you terminate the account because the beneficiary has died or is disabled, or if you withdraw funds not needed for college because the beneficiary has received a scholarship.

You can change the beneficiary to another qualifying family member at any time in order to keep the account going and avoid (or at least delay) taking non-qualified withdrawals when the original beneficiary doesn't need those funds.

 

[disneysteve]

it's a state thing. What if they want to go to an out of state college? You know what happens? You get hit with a big fat penalty!

I do know we don't want to pay a penalty. So 529 is out for us.

This is not true. 529 savings program funds can be used to pay qualifying expenses at any accredited college or university in the country and even some foreign schools. There is no penalty for doing this. In fact, this is the whole point of 529 programs.

Prepaid tuition plans are different. You can transfer the funds to another state but you may not get full value for them.

 

[OceanAnnie]

This is not true. 529 savings program funds can be used to pay qualifying expenses at any accredited college or university in the country and even some foreign schools. There is no penalty for doing this. In fact, this is the whole point of 529 programs.

Prepaid tuition plans are different. You can transfer the funds to another state but you may not get full value for them.

Thank you. You're right. I made a mistake. I must've gotten it confused with the advertisements in my state for the prepaid tuition plan. Sorry to everyone that is considering the 529.

I still don't think it is the right plan for us. It does have it's merits, but we're going with other options.

ETA- I could've sworn our state 529 plan is the same as the pre-paid plan!? I'm pretty sure it is one and the same.

ETA II- I just looked it up. It is one and the same. You are penalized if you don't use it in state and it is a 529 plan. These things can be very confusing.

 

[MeggerasMa]

Another perspective. Consider U.S.savings bonds purchased without the child's name on (except as beneficiary). The interest earned can be deductible at income tax time if the bonds were used for "qualified" tuition and fees for the childs college expenses. Since the bonds are not in the child's name (and I am assuming they would then be in the parents name) they would be considered an asset of the parent, not the child, when filling out the FAFSA form required if you want to possibly receive any type of student aid (be it grants or loans). Assets of the parents are considered at a lower percentage than the students assets. Hope this wasn't too confusing! Just trying to help.

 

[OceanAnnie]

Here is some good information from CNN money:

http://money.cnn.com/2005/08/10/pf/saving/willis_tips/index.htm

 

[georgina]

Thank you. You're right. I made a mistake. I must've gotten it confused with the advertisements in my state for the prepaid tuition plan. Sorry to everyone that is considering the 529.

I still don't think it is the right plan for us. It does have it's merits, but we're going with other options.

ETA- I could've sworn our state 529 plan is the same as the pre-paid plan!? I'm pretty sure it is one and the same.

ETA II- I just looked it up. It is one and the same. You are penalized if you don't use it in state and it is a 529 plan. These things can be very confusing.

My kids' 529's are with Vanguard and Fidelity, and I'm sure can be used at any accredited school. Since my in-laws opened them in their own names with the kids as beneficiaries, they won't count as the kids' assets at financial aid time. And if the kids get scholarships, I believe they can withdraw an equal sum from the 529 penalty-free. If one doesn't go to school, the money can be transferred to other family members. They're not for everyone, and since there are many different state plans, it is very confusing.

 

[disneymom3]

Hmmm, well I am not sure I am any less confused than I was! ha ha. I appreciate that link, Steve and will be looking into more of this for sure.

Thanks for all the answers. Clearly this is something that needs a lot more research but now I have a place to start.

 

[dcfromva]

Thank you. You're right. I made a mistake. I must've gotten it confused with the advertisements in my state for the prepaid tuition plan. Sorry to everyone that is considering the 529.

I still don't think it is the right plan for us. It does have it's merits, but we're going with other options.

ETA- I could've sworn our state 529 plan is the same as the pre-paid plan!? I'm pretty sure it is one and the same.

ETA II- I just looked it up. It is one and the same. You are penalized if you don't use it in state and it is a 529 plan. These things can be very confusing.

OceanAnnie,
I am curious as to which state this is?
A lot of states now offer two types of 529's. One being the pre-paid with a guaranteed tuition promise if used for in state public college tuition. The other type being different investment type accounts (most often with no guarantee on the rate of return--though a few do have some types of investment 529s which feature a guaranteed rate of return). At the very least, I would be surprised if they didn't permit a rollover from the pre-paid tuition to another type of 529.
If your own state plan does not have the flexibility you need, there are lots of other state plans which permit non-residents to invest in the investment type 529 plan they feature.
My own state (VA) offers a pre-paid plan in which you cannot lose any money. (Since it is a pre-paid plan, they only offer this type to residents.) If you go to an out of state or private school, they will pay out what you put into the account plus a reasonable rate of return or the average tuition for VA schools-but, never less than what you put into the plan. Or, they will permit you to rollover the money to the investment type 529 plan--which would permit you to use the money for tuition, fees, room, board and/or books.
One thing that really surprised me is the feedback I get from other parents (who have used the VA 529 pre-paid tuion plan) has been very good. Apparently, the customer service folks who administer the plan will help analyze which course of action is better for the client to make sure the benefit is maximized.

-DC

 

[Braque]

Check into the Roth IRA, the money grows tax free, college tuition withdrawals are allowed without penalty, and if it is not used by the kids it's retirement money.

 

[Chicago526]

Check into the Roth IRA, the money grows tax free, college tuition withdrawals are allowed without penalty, and if it is not used by the kids it's retirement money.

This sounds great! But what if your kid doesn't go to college, but you want to give him/her some of the money saved for tuition to help them buy a house, or pay for a wedding? Or to help them live while they are in trade school or an apprentice for a trade? One of the reasons my brother never when into the trades was because he had now way to support himself durring training (I think, this was a looooong time ago!).

If you want total flexibilty in how to spend the money, what's the best option?

 

[disneysteve]

Check into the Roth IRA, the money grows tax free, college tuition withdrawals are allowed without penalty, and if it is not used by the kids it's retirement money.

I periodically read someone recommending this and I just don't see how it is a good idea. If you spend your retirement money on your kid's education, what are you going to use for retirement? If the contribution limits on Roths weren't so low, maybe this would be worthwhile. But currently you can only put $4,000/year into a Roth ($8,000 if your spouse has one too). We're going to need that money for retirement. That's why we have those accounts.

 

[Braque]

I would never recommend taking out retirement money for college tuition - you can't get a loan for retirement but you can for tuition! But if you already participate in a 401K, you can also put money into the Roth, specifically as a college savings vehicle - yes, it's only $4K per year (only ) and it's not going to get you all the way there but it is an option.

If you want total flexibility and total control - I think you pretty much have to forgo any tax advantages and just invest in mutual funds that meet your risk tolerance and timeline for potential withdrawals. This is what we are doing.

I think about the the NY 529 each year and always pass by the tax advantages due to the constrictions on use - too bad Bush's Lifetime Savings Plans have been stalled for so many years.

 

[Minnie824]

I believe with 529's if one child does not go, you can roll it over to use for another child. Since OP has 3 kids, that may work as well.

 

[disneysteve]

yes, it's only $4K per year (only )

You might not find the Roth limits funny if it was your only option. We don't have 401K plans or company pensions, so our IRAs are our only tax-sheltered plans and believe me, putting away $8,000/year for retirement isn't nearly enough. Most of our "retirement" savings goes in fully taxable accounts, which makes saving for retirement much harder. Remember, IRA limits remained at $2,000 for a couple of decades. It is only in the past couple of years that they finally started upping those limits. Had they inflation-indexed them from day one, like they should have, the limits would be much higher than 4K now and would actually represent a more reasonable option for retirement savings.

 

[disneysteve]

I believe with 529's if one child does not go, you can roll it over to use for another child. Since OP has 3 kids, that may work as well.

This is true. Money in a 529 can be transferred to another beneficiary. That can be another child, a relative, grandchild or even the parent who decides to go back to school or get an advanced degree.

None of that matters for us as we have one child so I'm trying to be careful to not overfund the 529 since DD is the only one who will be using that money. It is a tough calculation though. If she goes to a state school, we'll need far less than if she goes to a private school.

 

[dcfromva]

So, now that we are in a much better financial situation than we have been in before, we are getting set to work on the college savings for the kids. We have three and the middle one is not a traditional education kind of a kid. He is only six, but trust me, I can tell. I will not be at all surprised if he doesn't attend college--I think of my two nephews for instance who are in construction. One, at the age of 22 is running his own business and is very successful. The other one, not so much, but he is gainfully employed and has a lot of skills.

If you have, say a 529 and that child doesn't go to college, but say enters the police academy instead and becomes an officer (as this middle one has been saying for three years he wants to do,) what happens to that money?

disneymom3,
Even if your child doesn't go to a traditional college, you may be able to use the money for other types of post-secondary education. Here is what the IRS has to say on the subject:
From the IRS publication on Qualified Tuition Programs (QTP)

"Eligible educational institution. For purposes of a QTP, this is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution."

I was just looking at the MN plan Here's a link -- (I am assuming that you are a resident of MN)... It looks like MN offers a match on contributions, if you meet an income test (it looks like up to 80K)--which is a pretty neat feature.

Here is a link to the rates of return...

Think about it another way. Suppose you decide to invest money in a normal investment fund which has performed quite well. If you receive any dividends along the way, you will be paying federal and state taxes in the year in which they are earned. When you cash the money in to be used for college, you will pay capital gains (federal/state) on the increase. On the other hand, if you had invested in a 529 plan and used it for a qualified expense, you would not have to pay those taxes.
Here is an example for each $1,000 you money grows in value. You would get to keep all of it if you spend it on a qualified expense if it were in a 529 plan. If you had a normal investment account, depending on your tax rate (and the capital gains on it), your earnings would be eroded by the taxes. Assuming they are long term gains, at a 15% Capital gain, that would be $150.00 of your child's education money going to uncle sam plus whatever the state cut is. Even at a 5% capital gain--that is $50.00 (plus the state cut) of money you don't get to keep.
If there are a lot of gains in a normal investment account, when you go to cash it in for your child to use for college--it could impact your overall tax situation.
If you take a 529 distribution, here is what the IRS says about it:

"Are Distributions Taxable
The part of a distribution representing the amount paid or contributed to a QTP does not have to be included in income. This is a return of the investment in the plan.
The designated beneficiary generally does not have to include in income any earnings distributed from a QTP if the total distribution is less than or equal to adjusted qualified education expenses (defined under Figuring the Taxable Portion of a Distribution, below). "

In your situation, you could transfer the funds over to another one of your children if it is not needed for college/or other qualified expense. This could work out to your advantage if you contribute at a higher rate to the oldest child--depending on how many years apart they are. Anything left over from the account from the oldest child could be transferred to the next child--and so on. If you have a short fall, you might have more years to make it up for the younger kids (depending on how many years they are apart).

And for financial aid purposes, if you don't quite have the entire amount saved for the child, if the parent is the account purchaser, the 529 money is considered an asset of the parent--so, it would count the same as any other regular investment asset the parent might have toward the expected family contribution.

-DC

 

[ceiligh1]

We have a 529 plan for our son. My understanding of it is similar to others in that he can use it anyplace for school charges. That said if he decides not to attend college (or doesnt need all of it) it can then be transfered to a relative for their use. If we decide to take out $ because he does not go and no one needs it a penalty will then be owed. That being said I found out from our EA that there is another way to go about it. Their is a high yeild account you can take out for your son that is not college specific. I cant remember the name but I will ask my DH tonight about it. I remember our EA saying that because his son didnt need all the money for school he was able to use the money to put a downpayment on a house (with parental approval). Or the parents could withdraw the money with no penalty and take everyone to WDW to each his own. I will try to find out the name of the plan. I remember thinking that I wish we had known about it before we had the 529 plan.