Please explain finance stuff to me
April 29, 2021 7:15 PM Subscribe
My kiddo is young, and I've got a savings account started for him. Kiddo is also in private school. I have been reading about all the different options for savings plans for the future, and 529 plans keep coming up, but I am apparently literally unable to comprehend what the benefit of a 529 is. Help?
I know 529s vary by location. We are in California. I just do not see the benefit of putting money in a 529 vs, say, an index fund account, but my peers act like I'm insane for not having a 529 account (and also not maxxing out private IRA contributions, and also not understanding how to fully take advantage of an HSA account, and, and, and....). I'm not entirely financially illiterate, but I just have no idea what options are out there nowadays.
Our family is in in an income bracket that Mr. Erst and I definitely did not grow up in, and there are options out there that I've never heard of and have no idea how to figure out.
Do I just need to sit down with some sort of financial advisor? And if so, how does one go about finding one of those? I have one account with Chase and they have cold-called me offering financial planning services, but they also sounded like car salespeople with a hard-sell tactic, so I declined.
Basically, I feel really like an awful person for saying this, but I seem to have slowly grown into a position where I have more money than I know exactly what to do with, and I seem to have no idea how to even approach handling it. Help?
I know 529s vary by location. We are in California. I just do not see the benefit of putting money in a 529 vs, say, an index fund account, but my peers act like I'm insane for not having a 529 account (and also not maxxing out private IRA contributions, and also not understanding how to fully take advantage of an HSA account, and, and, and....). I'm not entirely financially illiterate, but I just have no idea what options are out there nowadays.
Our family is in in an income bracket that Mr. Erst and I definitely did not grow up in, and there are options out there that I've never heard of and have no idea how to figure out.
Do I just need to sit down with some sort of financial advisor? And if so, how does one go about finding one of those? I have one account with Chase and they have cold-called me offering financial planning services, but they also sounded like car salespeople with a hard-sell tactic, so I declined.
Basically, I feel really like an awful person for saying this, but I seem to have slowly grown into a position where I have more money than I know exactly what to do with, and I seem to have no idea how to even approach handling it. Help?
For 529 plans, a good basic overview is: https://www.investopedia.com/terms/1/529plan.asp
I have found that website, Investopedia, is a good source of clear explanations of all sorts of things money-related. It's not the end-all be-all, but it answers a lot of questions.
As for more general "personal finance" type questions, I find that, believe it or not, the Reddit Personal Finance Wiki to be pretty good reading - it systematically answers your above-the-fold "Explain Finance Stuff To Me" question - and will give you a basic vocabulary to explore further.
posted by niicholas at 7:39 PM on April 29, 2021
I have found that website, Investopedia, is a good source of clear explanations of all sorts of things money-related. It's not the end-all be-all, but it answers a lot of questions.
As for more general "personal finance" type questions, I find that, believe it or not, the Reddit Personal Finance Wiki to be pretty good reading - it systematically answers your above-the-fold "Explain Finance Stuff To Me" question - and will give you a basic vocabulary to explore further.
posted by niicholas at 7:39 PM on April 29, 2021
529 contributions are tax-deductible, meaning that you don't pay taxes on those particular funds unless you end up using them for an ineligible purpose down the road. In general, if you can (legally!) avoid or delay paying taxes on something, you should.
The 529 is not, however, an investment class like an index fund. It's more like an account at a brokerage. The funds will be invested in something, almost certainly stocks or mutual funds. You may have some modest choice among options. Your state's 529's site should have that information.
posted by praemunire at 7:42 PM on April 29, 2021 [1 favorite]
The 529 is not, however, an investment class like an index fund. It's more like an account at a brokerage. The funds will be invested in something, almost certainly stocks or mutual funds. You may have some modest choice among options. Your state's 529's site should have that information.
posted by praemunire at 7:42 PM on April 29, 2021 [1 favorite]
Best answer: The short answer is "a 529 is a brokerage account, but when you take money out for college or private school you don't pay tax on it, and it grows tax free".
Things like 529s, 401Ks, IRAs, etc are really just investment accounts like you might already have. Where the differ is in "tax treatment". Basically:
For some accounts like 401K and IRA your put in "pre-tax" money. That means that if you put $1,000 in one of those, it's like your income was $1,000 less that year. It's the difference between getting $1,000 in income, paying $300 in taxes, and putting the resulting $700 in the bank and putting the entire $1000 in the bank. More invested up front means more growth over time.
Other accounts like Roth IRA and 529s are funded with regular "post-tax" money - like what you have in your bank. But you don't pay tax when you take money out. So if that $1,000 grows to $5,000, you can take the entire $5,000 out to pay for college, instead of taking $5,000 out and having to pay taxes on it and using the rest for college, like you would in a regular account.
An HSA is a special type of account that has tax advantages on both sides - pre-tax money on the way in, no tax on the way out.
All of the accounts grow tax free. Basically they act as magic shells surrounding your money, if you get a dividend on a stock (which you would normally pay taxes on) as long as it stays in the magic shell you don't pay taxes.
The catch with these accounts is that they come with restrictions. There's almost always a use restriction - education for 529, retirement for IRA/401K, medical expenses for an HSA. There's also almost always a limit on how much you can put in per year. Sometimes there are other restrictions; 401Ks only exist if you're working for a company, HSA only exist if you have a high deductible healthcare plan. The more of these magic shells you have, the better - assuming you're ok with the restrictions on how you can use the money, which you probably are once you're at a certain wealth level - it's less likely you'll need it in an emergency for something outside of the restrictions.
So when you're hearing about these accounts, you can apply a pretty standard set of questions to get a good idea about the basics (with answers for a 529):
A fee based financial advisor is a good idea, or at least everyone says so. I actually have a non-fee based one (i.e. one who tries to sell me products), but he's always quite open about what he's selling and hasn't ever been too pushy. That's worked out for me, but your mileage may vary.
posted by true at 10:00 PM on April 29, 2021 [14 favorites]
Things like 529s, 401Ks, IRAs, etc are really just investment accounts like you might already have. Where the differ is in "tax treatment". Basically:
For some accounts like 401K and IRA your put in "pre-tax" money. That means that if you put $1,000 in one of those, it's like your income was $1,000 less that year. It's the difference between getting $1,000 in income, paying $300 in taxes, and putting the resulting $700 in the bank and putting the entire $1000 in the bank. More invested up front means more growth over time.
Other accounts like Roth IRA and 529s are funded with regular "post-tax" money - like what you have in your bank. But you don't pay tax when you take money out. So if that $1,000 grows to $5,000, you can take the entire $5,000 out to pay for college, instead of taking $5,000 out and having to pay taxes on it and using the rest for college, like you would in a regular account.
An HSA is a special type of account that has tax advantages on both sides - pre-tax money on the way in, no tax on the way out.
All of the accounts grow tax free. Basically they act as magic shells surrounding your money, if you get a dividend on a stock (which you would normally pay taxes on) as long as it stays in the magic shell you don't pay taxes.
The catch with these accounts is that they come with restrictions. There's almost always a use restriction - education for 529, retirement for IRA/401K, medical expenses for an HSA. There's also almost always a limit on how much you can put in per year. Sometimes there are other restrictions; 401Ks only exist if you're working for a company, HSA only exist if you have a high deductible healthcare plan. The more of these magic shells you have, the better - assuming you're ok with the restrictions on how you can use the money, which you probably are once you're at a certain wealth level - it's less likely you'll need it in an emergency for something outside of the restrictions.
So when you're hearing about these accounts, you can apply a pretty standard set of questions to get a good idea about the basics (with answers for a 529):
- Do I fund it with pre-tax or post tax dollars? Post tax (in CA, other states differ for the state tax part)
- Does it grow tax free if I get dividends and such? Yes
- When I take money out, do I pay taxes on it? No
- What are the restrictions on taking money out? Educational expenses only, for college, private school, some other things
- What happens if I can't make those restrictions? A 529 plan beneficiary can be changed to a qualifying member of the family of the current beneficiary at any time, some exceptions for 'generating skipping' to a grandchild but not anything to worry about now.
A fee based financial advisor is a good idea, or at least everyone says so. I actually have a non-fee based one (i.e. one who tries to sell me products), but he's always quite open about what he's selling and hasn't ever been too pushy. That's worked out for me, but your mileage may vary.
posted by true at 10:00 PM on April 29, 2021 [14 favorites]
I think a key advantage you have is that your kid is in private school, so you can actually estimate expenses for a term that is closer than a hypothetical college your child may or may not want to go to in 10+ years. This makes it easier to decide how much money to invest in a 529 plan and actually use it in the near term, plus it gives you more opportunities to course-correct your investments along the years. If you’re talking to other private school parents, this may be why you feel like peers are acting like you’re crazy.
I personally haven’t put any money into a 529 plan for my public school kid. I live in a state without any obviously awesome college savings plans, and my kid may choose to take advantage of his dual citizenship and go to college outside the US (fingers crossed). We’ve prioritized retirement investments and have funneled extra cash into our mortgage principal. The internet says we should have refinanced the mortgage and put the extra money in a brokerage account, but I like the idea of paying off the mortgage early and using that cash flow for college expenses when we know more about what those will look like.
posted by Maarika at 6:43 AM on April 30, 2021
I personally haven’t put any money into a 529 plan for my public school kid. I live in a state without any obviously awesome college savings plans, and my kid may choose to take advantage of his dual citizenship and go to college outside the US (fingers crossed). We’ve prioritized retirement investments and have funneled extra cash into our mortgage principal. The internet says we should have refinanced the mortgage and put the extra money in a brokerage account, but I like the idea of paying off the mortgage early and using that cash flow for college expenses when we know more about what those will look like.
posted by Maarika at 6:43 AM on April 30, 2021
Best answer: I personally only see 529 accounts as good if you are a high income parent who is already maxxing your 401k and any other applicable tax-free accounts, like your HSA (have to have a high deductible plan - if you do they are a great upside) and IRAs.
After that, your high income will prevent your children from getting much in terms of need-based financial aid. 529s are post-tax, so only the gains grow tax-free if spent on educational expenses. That's fine if you are going to be spending money on college anyways.
A 401k, a regular IRA, and HSA will all lower your current income, and you will pay less income tax yearly.
I've also found that they have relatively limited investment options and relatively high fees, but I certainly haven't searched every provider.
posted by The_Vegetables at 8:30 AM on April 30, 2021 [1 favorite]
After that, your high income will prevent your children from getting much in terms of need-based financial aid. 529s are post-tax, so only the gains grow tax-free if spent on educational expenses. That's fine if you are going to be spending money on college anyways.
A 401k, a regular IRA, and HSA will all lower your current income, and you will pay less income tax yearly.
I've also found that they have relatively limited investment options and relatively high fees, but I certainly haven't searched every provider.
posted by The_Vegetables at 8:30 AM on April 30, 2021 [1 favorite]
I've also found that they have relatively limited investment options and relatively high fees, but I certainly haven't searched every provider.
"They" being 529 plans specifically.
posted by The_Vegetables at 8:39 AM on April 30, 2021
"They" being 529 plans specifically.
posted by The_Vegetables at 8:39 AM on April 30, 2021
Not to complicate things further (sorry), but different financial instruments are treated differently for purposes of financial aid. Here's a rundown for 529s.
FWIW, everyone's financial situations are different, but I live in CA and have 529s for both my kids.
posted by feckless at 9:47 AM on April 30, 2021
FWIW, everyone's financial situations are different, but I live in CA and have 529s for both my kids.
posted by feckless at 9:47 AM on April 30, 2021
Best answer: Not to complicate things further (sorry), but different financial instruments are treated differently for purposes of financial aid. Here's a rundown for 529s.
That article is kind of terrible and (really IMO) buries the lede that if you open a 529 plan with your kids' money (instead of your own - the UGMA/UMTA discussion) it can have serious financial differences for what amounts to a minor button click for most people.
I'm not sure why it keeps explaining things from the persepective of the 2nd $10k in the account, considering that's like one year of college costs nowadays. Also 5% is about 1 year's worth of investment gains, so you can say it is small, or you can say it really screws people who don't open 529 plans early, both are true.
In its favor, it does link to the EFC page. if you look at the EFC (expected family contribution) page (which is what you are trying to balance between a 529 plan, subsidized college grants, and direct out of pocket), you can see that the amount a student can earn that is protected from personal-contribtion calculations is only $7k, and after that they expect 50% to be given for education. For a parent, it's 22% to 47% of available income, which is pretty high, and is also per year.
Basically all this means is that you don't have to have very high of an income before you are disqualified for need-based financial aid, and the expected family contribution is pretty high for medium and high income families: " The overall average EFC is about $10,000, with an average of about $6,000 for students at community colleges and $14,000 at 4-year colleges."
So if you can't swing $14,000 per year minimum, then you need to open a 529 plan as early as possible. This is why your peers are freaking out.
posted by The_Vegetables at 11:01 AM on April 30, 2021
That article is kind of terrible and (really IMO) buries the lede that if you open a 529 plan with your kids' money (instead of your own - the UGMA/UMTA discussion) it can have serious financial differences for what amounts to a minor button click for most people.
I'm not sure why it keeps explaining things from the persepective of the 2nd $10k in the account, considering that's like one year of college costs nowadays. Also 5% is about 1 year's worth of investment gains, so you can say it is small, or you can say it really screws people who don't open 529 plans early, both are true.
In its favor, it does link to the EFC page. if you look at the EFC (expected family contribution) page (which is what you are trying to balance between a 529 plan, subsidized college grants, and direct out of pocket), you can see that the amount a student can earn that is protected from personal-contribtion calculations is only $7k, and after that they expect 50% to be given for education. For a parent, it's 22% to 47% of available income, which is pretty high, and is also per year.
Basically all this means is that you don't have to have very high of an income before you are disqualified for need-based financial aid, and the expected family contribution is pretty high for medium and high income families: " The overall average EFC is about $10,000, with an average of about $6,000 for students at community colleges and $14,000 at 4-year colleges."
So if you can't swing $14,000 per year minimum, then you need to open a 529 plan as early as possible. This is why your peers are freaking out.
posted by The_Vegetables at 11:01 AM on April 30, 2021
Was this prompted by the other question about 529s? If you haven't seen that then the information might be helpful context for your decisions. It's about the financial aid implications of spending down the 529.
posted by plonkee at 11:03 AM on April 30, 2021
posted by plonkee at 11:03 AM on April 30, 2021
I've opened three 529 accounts for grandchildren. The cost of Vanguard's plans is so low as to be minuscule. A complete non-issue in terms of cost. That's because you choose from among the various funds offered, about 20 choices when I opened the accounts, and then the funds are on autopilot. There's not active management, that is there is not a broker who moves money around and actively manages the accounts.
I chose several funds and divided up the investments, helpfully designated "aggressive" "moderate risk" and "conservative". Because my grandchildren are very young I'm focusing on aggressive growth, but will scale back the most aggressive investments towards moderate when they enter middle school; it's up to me, the owner of the accounts, to decide. I get quarterly paper statements that make me feel I'm leaving something tangible for their educational future, and when I got smallish legacies from various cherished relatives I socked some of it in those accounts so that their legacies would live on in the next generation.
There are zero federal tax implications, since the money I deposit has already been taxed, but in PA, where I live, I can deduct a portion of my yearly deposits from my state tax. CA may be different in this respect. And of course, when the money is used for education (includes things like computers!) there is no tax upon withdrawal.
posted by citygirl at 12:47 PM on April 30, 2021
I chose several funds and divided up the investments, helpfully designated "aggressive" "moderate risk" and "conservative". Because my grandchildren are very young I'm focusing on aggressive growth, but will scale back the most aggressive investments towards moderate when they enter middle school; it's up to me, the owner of the accounts, to decide. I get quarterly paper statements that make me feel I'm leaving something tangible for their educational future, and when I got smallish legacies from various cherished relatives I socked some of it in those accounts so that their legacies would live on in the next generation.
There are zero federal tax implications, since the money I deposit has already been taxed, but in PA, where I live, I can deduct a portion of my yearly deposits from my state tax. CA may be different in this respect. And of course, when the money is used for education (includes things like computers!) there is no tax upon withdrawal.
posted by citygirl at 12:47 PM on April 30, 2021
To clarify a murky point above, *contributions* to a 529 are *not* tax-deductible on a federal level. They are deductible against state income taxes in a few states. You contribute post-tax income to a 529. There is no immediate tax advantage.
But you invest within the 529. Meaning your contributions can earn or lose (an important point, you aren’t guaranteed any returns) money. If they earn money, those earnings are then not taxable income for you, state or federal.
posted by spitbull at 3:13 PM on April 30, 2021
But you invest within the 529. Meaning your contributions can earn or lose (an important point, you aren’t guaranteed any returns) money. If they earn money, those earnings are then not taxable income for you, state or federal.
posted by spitbull at 3:13 PM on April 30, 2021
It might be helpful to realise that in California, total cost per year (before any financial aid) at any one of the UCs is currently around $35k-$40k, at one of the CSUs, more like $24k-$28k, and a private college around $70k-$80k. Over the past two to three decades, the average annual inflation rate for college has been about twice the general average.
In your income bracket, college costs will be a very substantial expense and setting up savings and investments for them early will make an enormous difference. (This realisation may be contributing to your peers' championing of 529s, whether or not they all genuinely understand the benefits of them.)
posted by plonkee at 9:05 AM on May 1, 2021
In your income bracket, college costs will be a very substantial expense and setting up savings and investments for them early will make an enormous difference. (This realisation may be contributing to your peers' championing of 529s, whether or not they all genuinely understand the benefits of them.)
posted by plonkee at 9:05 AM on May 1, 2021
I've got a 529 account for each of the kids that the we and the Grandparents throw money into.
Now that my kids are reaching the age that they are earning a bit of money we've shifted our parental funds to a roth ira instead. The trick here is that you can only donate as much as the kids earn, up to $6000 a year (which we wouldn't be able to afford anyway).
I keep a detailed sheet of anything they've earned and fund their account for as much as we can muster while letting them keep their earned money. This has the benefit of growing tax free, will not be seen as income as a 529 account can be, and the money put into the account can be removed without penalty after 5 years or other conditions are met.
posted by Quack at 8:25 PM on May 2, 2021
Now that my kids are reaching the age that they are earning a bit of money we've shifted our parental funds to a roth ira instead. The trick here is that you can only donate as much as the kids earn, up to $6000 a year (which we wouldn't be able to afford anyway).
I keep a detailed sheet of anything they've earned and fund their account for as much as we can muster while letting them keep their earned money. This has the benefit of growing tax free, will not be seen as income as a 529 account can be, and the money put into the account can be removed without penalty after 5 years or other conditions are met.
posted by Quack at 8:25 PM on May 2, 2021
This thread is closed to new comments.
Prevailing wisdom says to max out your pre-tax retirement accounts before you start saving for educational expenses, since “you can’t borrow to retire, but your kids can get loans.”
There are a few personal finance flow charts that can help you with the basics, but a session with a fee-only financial planner might also be worth your money.
posted by chesty_a_arthur at 7:36 PM on April 29, 2021 [3 favorites]