The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children college expenses.
In the past 20 years, college expenses have skyrocketed exponentially putting many families in a difficult situation. Between 1998 and 2018, college tuition and fee have doubled in most private non-profit schools and more than tripled in most 4-year public colleges and universities.
With this article, I would like to share how the 529 plan can help you send your kids or grandkids to college.
Student Debt is Growing
The student debt has reached $1.56 trillion with a growing number of parents taking on student loans to pay for their children’ college expenses. The total number of US borrowers with student loan debt is now 44.7 million.
Amid this grim statistic, less than 30% of families are aware of the 529 plan. The 529 plan could be a powerful vehicle to save for college expenses. Fortunately, 529 plans have grown in popularity in the past 10 years. There are more than 13 million 529 accounts with an average size of $24,057.
Let’s break down some of the benefits of the 529 plan.
College Savings Made Easy
Nowadays, you can easily open an account with any 529 state plan in just a few minutes and manage it online. You can set up automatic contributions from your bank account. Also, many employers allow direct payroll deductions and some even offer a match. Your contributions and dividends are reinvested automatically., so you don’t have to worry about it yourself. As a parent, you can open a 529 plan with as little as $25 and contribute as low as $15 per pay period. Most direct plans have no application, sales, or maintenance fees. 529 plan is affordable even for those on a modest budget.
Flexible Investment Options
Most 529 plans provide a wide variety of professionally managed investment portfolios including age-based, indexed, and actively-managed options. The age-based option is an all-in-one portfolio series intended for those saving for college. The allocation automatically shifts from aggressive to conservative investments as your child approaches college age.
Alternatively, you can design your portfolio choosing
between a mix of actively managed and index funds, matching your risk
tolerance, timeline, and investment preferences. Some 529 plans offer guaranteed
options, which limit your investment risk but also cap your upside.
Earnings Grow Tax-Free
529 plan works similarly to the Roth IRA. You make post-tax contributions. And your investment earnings will grow free from federal and state income tax when used for qualified expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.
Your State May Offer
a Tax Break
Over 30 states offer a full or partial tax deduction or credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower significantly your state tax bill. However, these states usually require you to use the state-run 529 plan.
If you live in any of the remaining states that don’t offer any state tax deductions, such as California, you can open a 529 account in any state of your choice.
Use at Schools
529 funds can be used at any accredited university, college
or vocational school nationwide and more than 400 schools abroad. Basically,
any institution eligible to participate in a federal student aid program
qualifies. A 529 plan can be used to pay for tuition, certain room and board
costs, computers and related technology expenses as well as fees, books,
supplies, and other equipment.
The TCJA law of 2017 expanded the use of 529 funds and
allowed parents to use up to $10,000 annually per student for tuition expenses
at a public, private or religious elementary, middle, or high school. However,
please check with your 529 plan as not all states passed that provision
Smaller Impact on Scholarship and Financial Aid
Many parents worry that 529 savings can adversely affect
eligibility for scholarship and financial aid. Fortunately, 529 plan savings
have no impact on merit scholarships. You can even withdraw funds from the 529
plan penalty free up to the amount of the student scholarship.
For FAFSA, funds are typically treated as ownership of the parent, not the child, reducing the impact on financial aid application. A key component of the financial aid application is the Expected Family Contribution (EFC). Since 529 plans are considered parents’ assets, they are assessed at 5.64% of their value. For comparison, any accounts owned directly by the student such as custodial accounts (UTMAs, UGMAs), trusts and investment accounts are assessed at 20% of their value.
Lower Cost versus Borrowing Money
Starting the 529 plan early can save you and your child money in the long run. The tax advantages of the 529 plan plus the compounding growth over 18 years it will provide you with substantial long-term savings compared to taking a student loan.
Estate Tax Planning
Your 529 plan contributions may qualify for an annual gift
tax exclusion of $15,000 per year for single filers and $30,000 a year for
couples. The 529 plan is the only investment vehicle that allows you to
contribute up to 5 years’ worth of gifts at once — for a maximum of $75,000 for
a single filer and $150,000 for couples.
Other Family Members Can
Grandparents, as well as other family and friends, can make gifts to your 529 account. They can also set up their own 529 accounts and designate your child as a beneficiary. The grandparent-owned 529 account is not reportable on the student’s FAFSA, which is good for financial aid eligibility. However, any distributions to the student or the student’s school from a grandparent-owned 529 will be added to the student income on the following year’s FAFSA. Student income is assessed at 50%, which means if a grandparent pays $10,000 of college costs it would reduce the student’s eligibility for aid by $5,000.
Funds can be transferred
to ABLE Account
Achieving a Better Life Experience (ABLE) account was first introduced in 2014. The ABLE account works similarly to a 529 plan with certain conditions. It allows parents of children with disabilities to save for qualified education, job training, healthcare, and living expenses.
Under the TCJA law, 529 funds can be rolled over into an
ABLE account, without paying taxes or penalties.
Extra Funds Can Be Assigned to Other Family Members
Finally, if your child or grandchild doesn’t need all the money or his or her education plans change, you can designate a new beneficiary penalty-free so long as they’re an eligible member of your family. Moreover, you can even use the extra funds for your personal education and learning new skills.
If you’d like to discuss how to open a new 529 plan or make the most out of your existing 529 account, please reach out today. You learn more about our fee-only financial advisory services. I can meet you in one of our offices in San Francisco, Oakland, Walnut Creek, and Pleasant Hill areas or connect by phone. As a CFA® Charterholder with an MBA degree in Finance and 15+ years in the financial industry, I am ready to answer your questions.
I recently had the chance to work with several young families looking for help to build their wealth and improve their finances. We discussed a broad range of topics from buying a house, saving for retirement, savings for their kids’ college, budgeting and building legacy. As a financial advisor in the early 40s, I have personally gone through many of these questions and was happy to share my experience.
Some of my clients already had young children. Others are
expecting a new family member. Being a dad of a nine-month-old boy, I could
relate to many of their concerns. My experience helped me guide them through
the web of financial and investment questions.
While each family is unique, there are many common themes
amongst all couples. While each topic of them deserves a separate post, I will
try to summarize them for you.
Successful couples always find a way to communicate effectively. I always advise my clients to discuss their financial priorities and concerns. When partners talk to each other, they often discover that they have entirely different objectives. Having differences is normal as long as you have common goals. By building a strong partnership you will pursue your common goals while finding a common ground for your differences
Talking to each other will help you address any of the topics in this article.
If it helps, talk to an independent fiduciary financial advisor. We can help you get a more comprehensive and objective view of your finances. We often see blind spots that you haven’t recognized before.
Set your financial
Most life coaches will tell you that setting up specific goals is crucial in achieving success in life. It’s the same when it comes to your finances. Set specific short-term and long-term financial goals and stick to them. These milestones will guide you and help you make better financial decisions in the future.
There is nothing more important to any family wellbeing than budgeting. Many apps can help you budget your income and spending. You can also use an excel spreadsheet or an old fashion piece of paper. You can break down your expenses in various categories and groups similar to what I have below. Balance your budget and live within your means.
Utilities (Phone, Cable, Gas, Electric)
Non-Discretionary Flexible Expenses
Automotive (Fuel, Parking,
Dues & Subscriptions
One common issue I see amongst young couples is the dispersion of their assets. It’s very common for spouses to have multiple 401k, IRAs and savings accounts in various financial institutions and former employers. Consolidating your assets will help you get a more comprehensive view of your finances and manage them more efficiently.
Manage your debt
The US consumer debt has grown to record high levels. The relatively low-interest rates, rising real estate prices and the ever-growing college cost have pushed the total value of US household debt to $13.25 trillion. According to the New York Fed, here is how much Americans owe by age group.
Under 35: $67,400
75 and up: $34,500
For many young families who are combining their finances, managing their debt becomes a key priority in achieving financial independence.
Manage your credit
One way to lower your debt is having a high credit score. I always advise my clients to find out how much their credit score is. The credit score, also known as the FICO score, is a measure between 300 and 850 points. Higher scores indicate lower credit risk and often help you get a lower interest rate on your mortgage or personal loan. Each of the three national credit bureaus, Equifax, Experian, and TransUnion, provides an individual FICO score. All three companies have a proprietary database, methodology, and scoring system. You can sometimes see substantial differences in your credit score issued by those agencies.
Your FICO score is a sum of 64 different measurements. And
each agency calculates it slightly differently. As a rule, your credit score
depends mainly on the actual dollar amount of your debt, the debt to credit
ratio and your payment history. Being late on or missing your credit card
payments, maximizing your credit limits and applying for too many cards at once
will hurt your credit score.
Own a house or rent
Owning your first home is a common theme among my clients. However, the price of real estate in the Bay area, where I live, has skyrocketed in the past 10 years. The average home price in San Francisco according to Zillow is $1.3 million. The average home price in Palo Alto is $3.1 million. (Source: https://www.zillow.com/san-francisco-ca/home-values/ ). While not at this magnitude, home prices have risen in all major metropolitan areas around the country. Buying a home has become an impossible dream for many young families. Not surprisingly a recent survey by the Bank of the West has revealed that 46% of millennials have chosen to rent over buying a home, while another 11% are staying with their parents.
Buying a home in today’s market conditions is a big commitment and a highly personal decision. It depends on a range of factors including how long you are planning to live in the new home, available cash for a downpayment, job prospects, willingness to maintain your property, size of your family and so on.
Maximize your retirement
Did you know that in 2019 you can contribute up to $19,000 in your 401k? If you are in your 50s or older, you can add another $6,000 as a catch-up contribution. Maximizing your retirement savings will help you grow your wealth and build a cushion of solid retirement savings. Not to mention the fact that 401k contributions are tax-deferred and lower your current tax bill.
Unfortunately, many Americans are not saving aggressively for retirement. According to Fidelity, the average person in their 30’s have $42.7k in their 401k plan. people in their 40s own on average 103k.
If your 401k balance is higher than your age group you are already better off than the average American.
Here is how much Americans own in their 401 plan by age group
20 to 29 age: $11,500
30 to 39 age: $42,700
40 to 49 age: $103,500
50 to 59 age: $174,200
60 to 69 age: $192,800
For those serious about their retirement goals, Fidelity recommends having ten times your final salary in savings if you want to retire by age 67. They are also suggesting how to achieve this goal by age group.
By the age of 30: Have the equivalent of your starting salary saved
35 years old: Have two times your salary saved
40 years old: Have three times your salary saved
45 years old: Have four times your salary saved
50 years old: Have six times your salary saved
55 years old: Have seven times your salary saved
60 years old: Have eight times your salary saved
By age 67: Have 10 times your salary saved
Keep in mind that these are general guidelines. Everybody is different. Your family retirement goal is highly dependent on your individual circumstances, your lifestyle, spending habits, family size and alternative sources of income.
Know your risk
One common issue I see with young families is the substantial gap between their risk tolerance and the actual risk they take in their retirement and investment accounts. Risk tolerance is your emotional ability to accept risk as an investor.
I have seen clients who are conservative by nature but have a very aggressive portfolio. Or the opposite, there are aggressive investors with a large amount of cash or a large bond portfolio. Talking to a fiduciary financial advisor can help you understand your risk tolerance. You will be able to narrow that gap between your emotions and real-life needs and then connect them to your financial goals and milestones.
Diversification is the only free lunch you will get in investing. Diversifying your investments can reduce the overall risk of your portfolio. Without going into detail, owning a mix of uncorrelated assets will lower the long-term risk of your portfolio. I always recommend that you have a portion of your portfolio in US Large Cap Blue Chip Stocks and add some exposure to Small Cap, International, and Emerging Market Stocks, Bonds and Alternative Assets such as Gold and Real Estate.
Invest your idle cash
One common issue I have seen amongst some of my clients is holding a significant amount of cash in their investment and retirement accounts. The way I explain it is that most millennials are conservative investors. Many of them observed their parents’ negative experience during the financial crisis of 2008 and 2009. As a result, they became more risk-averse than their parents.
However, keeping ample cash in your retirement account in your 30s will not boost your wealth in the long run. You are probably losing money as inflation is deteriorating the purchasing power of your idle cash. Even if you are a very conservative investor, there are ways to invest in your retirement portfolio without taking on too much risk.
I talk about early retirement a lot often than one might imagine. The media and online bloggers have boosted the image of retiring early and made it sound a lot easier than it is. I am not saying that early retirement is an illusion, but it requires a great deal of personal and financial sacrifice. Unless you are born rich or rely on a huge payout, most people who retire early are very frugal and highly resourceful. If your goal is to retire early, you need to pay off your debt now, cut down spending and save, save and save.
Build-in tax diversification
While most of the time we talk about our 401k plans, there are other investment and retirement vehicles out there such as Roth IRA, Traditional IRA and even your brokerage account. They all have their own tax advantages and disadvantages. Even if you save a million bucks in your 401k plan, not all of it is yours. You must pay a cut to the IRS and your state treasury. Not to mention the fact that you can only withdraw your savings penalty-free after reaching 59 ½. Roth IRA and brokerage account do not lower your taxes when you make contributions, but they offer a lot more flexibility, liquidity, and some significant future tax advantages. In the case of Roth IRA, all your withdrawals can be tax-free when you retire. Your brokerage account provides you with immediate liquidity and lower long-term capital gains tax on realized gains.
Plan for child’s
Most parents will do anything for their children. But having kids is expensive. Whether a parent will stay at home and not earn a salary, or you decide to hire a nanny or pay for daycare, children will add an extra burden to your budget. Not to mention the extra money for clothes, food, entertainment (Disneyland) and even another seat on the plane.
Plan for college with
a 529 Plan
Many parents want to help their children pay for college or at least cover some of the expenses. 529 plan is a convenient, relatively inexpensive and tax-advantageous way to save for qualified college expenses. Sadly, only 29% of US families are familiar with the plan. Most states have their own state-run 529 plan. Some states even allow state tax deductions for 529 contributions. Most 529 plans have various active, passive and age-based investment options. You can link your checking account to your 529 plan and set-up regular monthly contributions. There are plentiful resources about 529 plans in your state. I am happy to answer questions if you contact me directly.
Protect your legacy
Many young families want to protect their children in case of sudden death or a medical emergency. However, many others don’t want to talk about it at all. I agree it’s not a pleasant conversation. Here in California, unless you have an established estate, in case of your death all your assets will go to probate and will have to be distributed by the court. The probate is a public, lengthy and expensive process. When my son was born my wife and I set up an estate, created our wills and assigned guardians, and trustees to our newly established trust.
The process of protecting your legacy is called estate planning. Like everything else, it’s highly personalized depending on the size of your family, the variety of assets you own, your income sources, your charitable aptitude, and so on. Talking to an experienced estate attorney can help you find the best decision for yourself and your family.
I never sell insurance to my clients. However, if you are in a situation where you are the sole bread earner in the household, it makes a lot of sense to consider term life and disability insurance, which can cover your loved ones if something were to happen to you.
I realize that this is a very general, kind of catch-all checkpoint but let me give it a try. No matter what happens in your life right now, I guarantee you a year or two from now things will be different. Life changes all the time – you get a new job, you have a baby, you need to buy a new car, or your company goes public, and your stock options make you a millionaire. Whatever that is, think ahead. Proper planning could save you a lot of money and frustration in the long run.
I realize that this checklist is not complete. Every family is unique. Each one of you has very different circumstances, financial priorities, and life goals. There is never a one-size-fits-all solution for any family out there. If you contact me directly, I will be happy to address your questions.
About the author:
Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized investment management and financial planning services to individuals and families. To learn more visit our Private Client Services page here. Additionally, we offer Outsourced Chief Investment Officer services to professional advisors (RIAs), family offices, endowments, defined benefit plans, and other institutional clients. To find out more visit our OCIO page here.
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Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,
Small and mid-size business are the backbone of the US economy. Entrepreneurship and creativity have been moving the American economy for centuries. In fact, US has one of the best grooming environments for start-ups and small businesses. Many flagship consumer brands like McDonald’s, Starbucks, and Apple started very small with one restaurant, a coffee shop, and a garage workshop to become international leaders in their industry.
Business owners spend several years building up their business. They invest a significant amount of personal time and capital to grow their companies. Almost always these entrepreneurs will have their family fortune locked in their business. Those who succeed can go public or pass their wealth to the next generation.
Entrepreneurs are a special breed. Many have a vision or a single idea that that drives their pursuit for success. Others have a unique skill or talent that make them stand out from their competitors. They are independent, self-driven and bold.
Focused on their business, more often than not entrepreneurs ignore or delay their personal financial planning. In this post, I would like to discuss several practical steps that business owners can follow to establish their successful financial plan.
The first and most crucial step in the personal financial planning process is setting your short and long-term financial goals. In many cases, the business goals can interfere and clash over personal financial goals. Business goals to expand into a new market or purchase a new factory can negatively interfere with your personal goals such as saving for retirement or college education for your children. Striking the right balance between your business and personal goals is key to achieving them. Prioritizing one over the other may hurt your long-term financial success.
Explore different financing alternatives
Every new business idea requires capital to start. The success of the venture depends on the owner’s ability to secure financing. Sometimes, the funding comes from personal savings or the sale of a property. Other times, the owner needs to look for external funding within his or her social circle or even approach a financial institution. The external financing can be in the form of a loan or equity stake.
Both debt and equity financing come with embedded costs. The cost can vary depending on the company’s size, industry, history, economic conditions, etc. One of the main advantages of debt financing is that the interest on the loan is tax deductible. One the other hand equity financing may allow for more flexibility.
Another great way of financing your idea is your customers. Indeed, your clients are one of the best and inexpensive sources of financing. If your customers love your product, they will be willing to give you an advance payment, subscribe to your platform or consider a product/service exchange.
In any case, the entrepreneurs should seek to minimize the overall cost of capital of its business by exploring multiple financing channels.
Even the best idea can fail if it doesn’t generate profit. In simple numerical terms, the company revenue should be higher than its expenses. Many ventures do not succeed because the company cannot generate enough revenue to cover all costs. Clearly, the first answer will be to generate more revenue. However, many successful companies are notorious with their focus on cost control. Business owners must stay on top of their expenses. They must track and analyze your cost. Owners should look for operational deficiencies and overlaps, result-based compensation, economies of scale and ways to increase productivity.
Businesses need cash to maintain healthy growth. Not surprisingly, the prominent investor Warrant Buffet prefers to invest in companies generating significant cash flows. The capacity to produce cash from its operations will determine the company’s ability to pay its employees, creditors, and vendors. Building a disciplined system of managing receivables and payables and maintaining a cash buffer for emergencies are keys for effective cash flow management.
Manage your taxes
Filing and paying taxes is a long and painful process. Tax law is very complex. Many hidden threats can trigger tax events for you. There are also many opportunities to save on taxes. Often, your tax bill depends on your company legal status. Sole proprietors have different taxation rule from c-corporation. Speak to an accountant or tax lawyer to find out what legal status works best for you. To avoid missed opportunities and last-minute mistakes, you have to prepare for the filing process in advance. Start early. Keep a clean record of all your expenses. Track all tax filing dates. Remember to pay all federal and state taxes, social security, Medicare, local permits, and fees. Consider using a professional bookkeeping software and working with a CPA.
Risk comes in all shapes and forms – business risk, operational risk, financial risk, disability risk and so on. Managing the risk from different sources is a mandatory skill for any successful business owner and executive. External threats can impose significant obstacles to profitability and expansion but if managed successfully can create substantial opportunities for long-term growth.
Business threats can come from new competitors, new technology, changes in consumer demand, new regulatory requirements and so on. Business owners have to be on top of these changes and often even drive the change.
Operational risk impacts the companies’ ability to serve its customers.
Financial risk can come from interest rates, volatile stock markets, and liquidity crunches. Macroeconomic factors can affect your clients’ ability to pay off their debt. Having a solid financial strategy, building buffers and managing cash will allow the business to withstand unexpected financial turbulence.
Short-term and long-term disability will prohibit the owners and key employees to perform their duties. Injuries and sickness of key personnel can significantly hurt any business. Prolonged disability can limit owners’ ability to make a living, support their families and grow their business. Having disability insurance can help bridge the financial gap during a time of recovery. Moreover, having a disaster plan can save your business at times of emergencies and unforeseen circumstances.
Establish a retirement plan
Having a company retirement plan is an excellent way to save money in the long run. A pension plan contributions could reduce current taxes and boost employee’s loyalty.
While there are few alternatives – 401k, SEP IRA, and SIMPLE IRA. I am a big supporter of 401k plans. Although they are little more expensive to establish and run, they provide the highest contribution allowance over all other options.
The maximum employee contribution for 2016 is $18,000. The employer can match up to $35,000 for a total of $53,000. Individuals over 50 can add a catch-up contribution of $6,000 for a total of $59,000 annual contribution.
Self-employed individuals can also take advantage of this option by setting up a solo 401k plan. Moreover, they can contribute up to $53,000, $18,000 as an employee of your company and $35,000 as an employer.
Build a safety net
Creating a safety net is a critical step to protecting your wealth. Many business owners hold a substantial amount of their assets tied up to their personal business. By doing it, they expose themselves to a concentrated risk in one company or industry. Any economic developments that can adversely impact that particular sector can also hurt their personal wealth.
The best way to build a strong safety net is asset diversification. Owners can significantly decrease the overall risk of their portfolio when investing in a broad and uncorrelated range of assets, sectors, and regions.
Start your estate planning
Estate planning is the process of arranging the disposal of your assets after your passing. It further involves your family members, other individuals, and charitable organizations. Estate planning starts with setting up a family trust and personal will and can also affect financial, tax, medical and business planning. Additionally, you can use estate planning to eliminate uncertainties over the administration of a probate and to maximize the value of the estate by reducing taxes and other expenses. The ultimate goal of estate planning can be determined by your specific goals and may be as simple or complex as your needs dictate.
Plan for business succession
A successful business can impact various parties such as owners, employees, contractors, vendors, clients, landlords, and suppliers. Therefore, creating a business succession plan will ensure that all parties interests are met in the event you decide to discontinue your business or pass it to another person. Moreover, a robust plan will address numerous tax and financial issues which will result from the succession. The complexity of the succession plan will depend on the size, industry and legal status of your business.
About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to busy families and business owners.
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