Alternatives to 529 College Savings Plans: What They Didn’t Tell You!
Despite the favorable tax treatment on 529 Plans, if any of the money is not used for education costs, the account owner will find themselves owing income tax on the withdrawals and a 10% additional penalty on earnings. Ouch! This can be avoided by changing the account beneficiary, but that’s not always a reasonable option. Even though 529 Plans work quite well from a tax perspective, that still doesn’t make them suitable for all family situations.
Possible Solutions? Enter IRA’s and Whole Life Insurance! These vehicles provide attractive features for use in college planning under many circumstances! Other alternatives exist as well, but these are two of my favorites when it comes to effectiveness.
IRA’s– Traditional IRA and Roth IRA accounts grow tax-deferred just like a 529 Plan, but there can be some advantages to using an IRA for college expenses.
Pros- They effectively function as tax-deferred college savings plans, as the early withdrawal penalty is waived on qualifying expenses. If the child does not go to college, there’s no pressure or losses due to penalties. Can withdraw contributions portion completely tax-free for college. Assets remain in control of parents. Funds in an IRA are sheltered from financial aid needs analysis.
Cons- You’re using up retirement savings. Withdrawals count as unearned income, which would affect financial aid in the following years. Funds must be taken the same year the qualified education expense is paid to avoid tax and penalties. You can’t “repay” money that you took out for college.
Whole Life Insurance– Whole life insurance cash values can be borrowed from a policy for any reason, no questions asked. This can be a great place to pull college funds from if the money is available. There are other types of permanent life insurance that can build up cash values for college, but because of the safety features and guarantees I’m going to limit this discussion to whole life insurance.
Pros- Currently invisible to all financial aid calculations. Policies have guaranteed minimum interest rates. Returns have historically been very reliable and steady. Policy gains are retained, unless borrowed/surrendered or used for missed premiums. Money is borrowed tax-free and penalty-free. Policy continues to earn interest, even on borrowed funds, similar to how home equity behaves.
Cons- Borrowed funds accrue interest, similar to a student loan…but remember they still earn interest, so this can be offset if done right. Needs a longer time horizon to build up necessary cash values. Policy should be specifically structured for cash buildup, and lower death benefit. Borrowing funds will decrease policy death benefits.
(I made a case study video on this whole life insurance method, which applies to more than just college planning. It’s often referred to as the “Infinite Banking Concept” and you can watch it here: https://www.youtube.com/watch?v=dUGNJEQf0oY)
The bottom line on 529 College Savings Plans: they can work quite well over a longer period of time but, just like any market investments, they carry risk of loss. Furthermore, if the money is not used for college, you’re going to run into some trouble. Keep this in mind and do not rule out alternatives! Get with a professional and explore your options before making any big decisions. No matter which accounts you use, all interest-bearing solutions work best over a long period of time, uninterrupted. Start saving AS EARLY AS POSSIBLE to maximize results!
A guest post by Kyle A. Davis, Chartered Financial Consultant® and president of Integrity American Group, LLC. He is a Florida native and an advocate for financial literacy and practical money education. When not assisting clients with their retirement and college planning, he creates educational videos on financial wellness and offers free resources on his personal finance website www.kyledavisfinancial.com.