What are the differences between the two types of 529 plans?

Ralph
00:00:00

Are you lying awake at night worried about how you'll afford your child's college education? Maybe You've heard about 529 plans, but you're feeling overwhelmed by the options and confused about which type might be right for your family.

Well, today I'm going to walk you through a complete breakdown of both types of 529 plans and I'm going to share some real stories of families who've used these plans to secure their child's educational futures.

The question we're answering today is what are the differences between the two types of 529 plans and how are they used for an effective college spending plan?

Narrator
00:00:34

Welcome to the Ask Ralph podcast where listening to an experienced financial professional with over 30 years of experience can help you make sense of confusing questions, current headlines and industry trends about taxes, small business, financial decision making, investment strategies, and even the art of proper budgeting. Ask Ralph makes the complex simple by sharing his real world knowledge from a Christian perspective with all things financial.

Now here's your host, Ralph Estep Jr.

Ralph
00:01:02

Let me start by thanking you for joining me today. My goal today is to help you achieve financial success while growing in your faith. That's why I do what I do every day. Now yesterday, if you missed the show, we talked about 7 credit card debt myths that nobody should believe. And listen, that episode right there could potentially save you thousands of dollars. So I'm going to encourage you to, if you missed it to go check it out.

Well, we got a great listener question today. And this one comes to us from Jennifer in Atlanta. This is what Jennifer said. She said, "Dear Ralph, my husband and I have been blessed with two young children, ages 3 and 5. We want to start saving for their college education, but we're confused about 529 plans. I've heard there are two different types and I don't want to make the wrong choice. Can you help us understand the differences and guide us in making the right decision?"

Well, Jennifer, first of all, thank you for your question. You certainly got your hands full with a three-year-old and a five-year-old. I remember when my two were young. Mine are 23 and 27 now. But there are about three and a half years apart. So you're kind of feeling the same thing I have. And listen, I get it. College planning can feel completely overwhelming. Well, that's what I'm going to answer on today's show, I've got your college cheat sheet. Now, if you've got a question like Jennifer, one of the things you can do is go to justaskralph.com.

You could submit your question there, or even better, you can join me each Tuesday night at 7:00 PM when the Ask Ralph show goes live. That's right, live every Tuesday night at 7:00 PM Eastern time. If you want to look for it, you can go to askralphpodcast.com/live. We're on YouTube, Rumble. We're on Facebook groups. And you can catch it right there live.

But Jennifer, your question reminds me of a very powerful verse from the Bible. You know I always like to start the show with a word from the word of God. And this one comes to us from Proverbs 22:6. And it tells us this. "Train up a child in a way he should go, and when he is old, he will not depart from it." See, because what this verse is really saying is it's not just about spiritual training. We got to prepare our children for the future. And one of the best ways we can do that is by planning for their education. So Jennifer, you've gotten this great topic to talk about today and that's exactly what we're going to handle.

Well, let me start by breaking down the key differences between the two types of 529 plans in a way that will help you make an informed decision for your family's educational future. Let's start with the first type. And that's what we call the traditional 529 college savings plans. The beauty of these things is all the earnings grow tax deferred. And when you go to take those withdrawals so long as it's used for qualified educational expenses, they're typically federal tax-free and the thing that's nice about these 529 plans is they provide greater investment flexibility.

I'll talk about that in a few minutes when I talk about the other kind of plans. Now here's the key. 529 plans can be used at any accredited educational institution. And the other great thing about the traditional 529 plan is they cover a broad range of expenses. Those are things like tuition, books, room and board and even technology needs.

So yes, you can buy that laptop or get that tablet computer with those monies from that traditional 529 plans. So that's again, first type 529 college savings plan. We talked about what makes those, and we'll get into a little more detail here in a few minutes. The second type is what is called a prepaid tuition plan.

Now these work a little differently. What's you're effectively doing here is you're essentially locking in today's tuition rate based on the cost at a public institution. So like I said, normally these are public institutions. And here's the little bit of a rub. The money that you put in there, you can only use for tuition and mandatory fees.

So it's not going to cover those things like we talked about books, room and board technology needs. It's not going to cover those things. The other thing is usually at in-state public universities. That's what they're, that's what they're basically designed for. It's a prepaid tuition plan for those public universities.

See the main point, if you think about nothing else here. The main difference between the two. This prepaid tuition plan, it basically boils down to us, offering you protection against future tuition inflation. That's the thing. Think of it as a hedge against inflation of those costs. So you might ask Ralph, what is the key investment consideration with these plans? Big picture. Both of these function as tax advantage accounts. You're not going to pay tax on the earnings from them so long as those monies are used at the end for education.

And here's the thing, I got to admit, these are super powerful tools for long term education savings, which is one of the things you asked about Jennifer. You want to define what are some tools I can use? Both of these are great. The key in either one of these that you pick is to start early.

You got to start early and you got to contribute consistently. Because that's the key. And it's an important factor to consider is timing because just like a retirement planning, the key is to start early and take advantage of that compound interest. The sooner you start, the more that money can grow on itself and that interest can compound and compound. And listen, that's especially true for these college savings plans. Now, here's the thing that's really beautiful about this. Those investment choices can grow substantially over time.

So let's talk about some real-life examples that I've seen in my own practice. This one, we're going to call story number one. And that's the prepaid tuition plan success. Well about 5 years ago, I met with a couple, they were, we'll call them the Johnson family. They met with me. They were worried about college planning.

Now, both of the Johnson's were public school teachers. They sold a value in education. They make decent salaries, but it's a modest salary. And here's the beauty of the whole thing. Their daughter was a straight A student. And I remembered him telling me, she loved animals and wanted to be a veterinarian. But as we are meeting, they share where they said Ralph, we've only got $243 in our savings for college. And they had this realization.

They knew they were not prepared. But here's the thing. They had faith, and they were willing to act. See that's the key. Faith and a willingness to act is though, is the recipe for success in this. So you might be asking, what did I do? I looked at their finances. I looked at their overall financial situation.

See, most of the time when I have worked with clients, we start with taking a realistic view of where you are today. So we did that. We created a budget. One of the things I call is that intentional spending plan. And when we did that, we looked under the hood. We found that they could redirect and listen to this, $275 per month that they could put into money to set aside for college savings.

Now, what did that look like? Well, it meant that we're going to have to cut back on eating out. And it also had to find a more affordable cell phone plan. See, here's the thing. Big picture. There are normally always options. Now in their case, they chose the prepaid tuition plan. They felt that would be the best fit for them. They knew it would be a consistent sacrifice.

They'd have to put aside that money each month. They'd have to cut back on that eat. Now if you're looking for more affordable things to do. But they realized that it was going to be a consistent sacrifice and listen. It was really totally shared me. They said wrap during those tight months, it was tough.

Like that time when their car needed repairs or they wanted to take that vacation, that seemed like everybody else was taken vacations. But here's a difference. They remained faithful to their commitment. They saw it as a sacrifice. They needed to make for their daughter. They put the value in the daughter.

They wanted to see her achieve her dream. They wanted to see her get to be that veterinarian that she always dreamed about doing. So you might be asking Ralph what happened. Well, guess what? Here's the best part of their story? Their daughter started college last year. Now think about this. When they originally got into this savings plan. The tuition was a certain rate, but between then, and when she started tuition had actually increased 45%. But the beauty of their plan was they had locked in their rates. And when we looked at it, it saved them over $45,000.

Think about that for a minute. That's $45,000 in savings all from those small, consistent contributions. Now she's in her second year in pre vet studies. And here's the best part. She's debt-free. And the couple recently told me, they said, Ralph those small sacrifices we're worth every penny. All those times we decided to eat in rather than eating out.

We look for ways to scrimp and save. Those small sacrifices are worth every penny. So here's my key takeaway from this story. Combining faith with a disciplined financial plan will yield extraordinary results. You have to be consistent. You have to just do it, do it, have faith and do it. Well, let's look at the second story.

I'm going to call this the education savings plan journey. Let me introduce my clients, the Martinez family. Now they came in with their son. The husband worked in construction and the wife ran a small online home business. And at this point, they're not sure what their son would attend, what kind of college he would go to, but they wanted to give him that pathway to opportunity.

See, this was an opportunity that neither of them had. It was a dream to them to see this for their own son. They had nobody in their family that had ever even gone to college before. So you might be asking Ralph, what did you do for the Martinez family? Well for them, we set up that education savings plan. That traditional 529 plan. And here's the beauty of it.

It started with just a $100 a month that they had to set aside. And what we did is as their income grew, they increase the amount. They had this mentality where they put their savings first. And that's the key to the whole thing. And listen, they invested monthly for 15 years. Now, this, this happened, so this one goes way back.

This is when I first started my own practice. Even during the 2008 recession, a lot of people were panicking. Here's the thing. If you don't know about this, in 2008, people were taking out their money because they were scared. They got out of the market. They were worried to death about the market was going to crash and they thought about all these terrible things, but not the Martinez family. They kept their faith. They kept their persistence and listen to this.

Here's the outcome of this. Their initial investment total up to be $54,000. But in the end, because of compound interest, because of their consistency, it had grown to a $115,000. That's more than double what they put into it and that's thanks to that tax-free growth and thanks to that compound interest. So you might be asking Ralph, where is their son today?

Well, let me tell you, he's attending a private university. He's studying engineering. That 529 plan covered not just his tuition, but as I talked about earlier, covered his books, it covered his laptop and even his housing costs, it covered it all. And let me tell you right now, when I meet with the Martinez, they come in every year, they get their taxes return, his mother always tears up when she talks about how God turned their small faithful steps into such an abundant provision for their son. And listen. He's likely going to be the first college grad in their family. And all I can say to that is amen. And let me move on to my last story and I call this one the flexible approach blessing. Let me tell you about the Williams family.

This is my favorite story of the whole thing. Why? Because this shows God's unexpected blessings. Now the Williams started an education savings plan when their daughter was born. That 529 plan. And they were very consistent. They made that annual contribution. Now on their case, what they would do is when their daughter got money for her birthday, or she got money for Christmas, they would take a large portion of that and put that into the 529 plan, and even encouraged their family, you know, the grandparents and all the aunts and uncles to contribute money to that 529.

So each year the plan was working. They were being consistent. Well then something really bad happened. In their daughter's junior high school, the husband lost his job. And I remember him talking to me about this. He said, Ralph, I don't know what I'm going to do. I don't know how to tell her that she may have to give up her dream of going to college. But I'll tell you why

I like this story so much is that even during that time, God had other plans. And listen, if you listen to this show, you know, a lot of times God has plans that were not expecting. I didn't tell you the best part. So their daughter, her name was Hannah. She was a great student. She studied hard. And guess what? Her academic excellence landed her a full scholarship. So you're saying Ralph, that's great.

So they had this struggle with a husband lost his job, but she, she got that full scholarship. But Ralph, don't they still have that 529 plan? Yup, they sure do. And here's the beauty of that. They were able to take that 529 plan, all that money they had set aside, and they were able to transfer the balance to their son. And here's the best part.

There was no penalties. It was awesome. So in the end, what seemed like a potential financial crisis turned into a double blessing. Not only do their daughter attend college on a full scholarship, but now their son has a significant head start on his own education funding. He just has that head start. And this story reminds us that even sometimes with our careful financial planning, things work out differently than we expect.

I don't know how many times I, I felt that same way. You know, I had this plan. But it worked out differently, but see, here's the deal with God's grace, many times it worked out better than we could've ever imagined. So I just say praise God to that. Well, you might be at this point saying, Ralph, what do these real-life examples tell us? Well, let me break it down for you. Number one. They show us how 529 can be a powerful tool for college savings. They just can be. And number two, they also demonstrate something more important when we combine faithful stewardship with wise financial planning. That's the whole point of this show. When you do that, when you combine that faithful stewardship and that wise financial planning, we create opportunities that will impact generations.

Think about that. I have clients now that kids are in college, they will be the first kids in college in their families ever. They're going to be the first college graduates in those families ever. And what was the key? The key is starting early and remaining consistent, remaining faithful. And another key is to trust God.

That's the end. When the fellow lost his job, when things happen in life, car repairs happen, all these things, it happens to all of us. But the key is to trust God, because we got to understand he will multiply our efforts for his glory. So you might be asking, Ralph, what are the key points here? I'm ready to start using these for my children. So, let me break down again, just to make it very clear. I said there are two types.

There's the prepaid tuition plan. And there's the education savings plan. With the prepaid tuition plans, which people will call the 520, excuse me, which people will call that, that, that prepaid tuition plan, not the 529 plan on top of that in a second. What you're doing here is you're locking in current tuition rates.

You think about it like insurance. You're saying to the institution, yep. My child is going to go there. I want to pay today's rate 10 years from now, 15 years from now. Whatever that looks like. Now the only downside to this, is it's limited to most in-state public universities. Most private schools aren't going to do this.

And there really is not much investment risk because you're not putting this money in the market like you are on those, traditional 529 plans. So you don't have that investment risk because the only reason you have is that the university says, no, we're not going to take your child, but that's kind of baked into the cake.

The other big problem with these prepaid tuition plans is their restrictive use. They're only going to cover, like we said, tuition and mandatory fees. They're not going to cover those expenses like books, room and board, technology, all that kind of stuff. So understanding it, prepaid tuition plan, you're locking into current tuition rates. Like I said, it's like insurance, mostly at public state universities, but there's no risk at all because you're locking in that current rate.

Now the other one is what we call the education savings plans. That's the one you hear about in the news. Those 529 plans. Now the beauty of these is they can be used at any eligible institution. There's a long list of those. The other benefit to these is you could potentially grow your money at higher returns because you're investing this money in the market.

You're not just locking into one school. It's basically an investment vehicle and you can pretty much choose what you want to invest in. It's also got more flexible spending options. Like we talked about. You can spend it on books, tuition, fees. You can use it on room and board. You can do it on technology. But there is some investment risk involved.

Like I said, you can grow higher returns, but there's also investment risk. But it's a tradeoff. Your investments are in the market. So that's another thing to consider. Now, some state sponsored plans offer tax benefits at the state loan. I'm not going to really get into that. There are residents requirements.

There's beneficiary concerns. You've got to look at am I going to move eventually? And those investments vary state by state. And again, you got to look at the risk and reward. So let's talk about some general rules here. You got to understand what qualified education expenses are. And as long as you're using for that, it's tax-free, you've also got at the front end, get a clear picture of what is covered.

Like I talked about between the two plans. If your goal is to have it cover all those other ancillary college expenses, that prepaid tuition plan is not going to work. Now the other thing you got to understand, there are penalties. If you use it for something else, because it basically becomes taxable income and it's subject to a 10% penalty.

Now here's one of the beauties of the thing in. A general topic here. There is generally no annual contribution level at the federal level. There you can put as much as you want in it. Now states might have different impacts, but one of the things you want to consider and talk to a professional. Is there are some gift hap to fit.

Let me say that three times over. There are some gift tax implications, but one of the beauties of these 529 plans is a, let you do. What's called a five-year gift tech averaging. So let me talk about that. So let's say grandparents want to put money into little Susie's 5 29 plan, but they want to do it all at once.

Now, generally there could be some gift tax implications. If that amount is over that annual gift tax amount. But one of the beauties of the 5 29 plans is even if you do it upfront. As long as you can stretch those things over five years from a gift tax perspective, there's no issue, which is great because now you can have grandparents fund these plans. And you might be asking Ralph, who controls these accounts?

Well, that's the beauty of the thing. The parents control the accounts. So in this situation we had where a person got a full college scholarship, the parents were able to change those beneficiaries. And one of the questions I get asked a lot is how about financial aid? Well, here's the beauty of this. For most cases, 529 plans are parental assets.

So they have little effect on financial aid. Now I got to tell you some colleges have their own policies. So you've got to look at those parts of the puzzle and decide which best for you. Look at your overall financial plans and listen. I'm not saying that the 529 is the end all be all. I think it's a component.

It's a part of that financial puzzle. You've got to create, uh, a plan for the long run. Just figure it out. You know, don't put all your eggs in all. Listen to only mess up. We're going to do is a 5 29 plan or the only investment we're going to do is that prepaid tuition plan. It's all part of this overall bigger financial goal.

And I'm going to share some action steps for you in just a few moments. But let me ask you a few questions. Do you feel overwhelmed with your finances? Do you want to find financial freedom? Do you want to align your finances with your faith? Do you feel like your dreams are slipping away? Do you feel frustrated, hopeless.

And do you feel stuck? Well guess what? This is the greatest neutral ever here. There is hope. I want to invite you to join the Ask Ralph show insiders group. We've got a community of people who feel the same as you. These are people who are facing these same challenges. They're looking for ways to fund their children's education.

They're looking for ways to get out of debt. The difference is they're mastering their finances. They're living their dreams. They're finding peace of mind. And listen, they're feeling the same pain points as you and me and everybody else. But the difference is they're seeking to balance their finances with their faith.

And best of all, the insiders group is sharing answers. Yes. We're sharing solutions. But larger than that in my humble opinion, the best part of the insiders group is we're sharing hope. Apply to join our community. Just go to askralphpodcast.com/group and complete questionnaire. Do it now and become a member of the insider's team. Now I promise you those action steps.

So let me get to it. Number one. Evaluate your state's 529 plan options. I want to put some links in the show notes to talk about how to do that. You can look at geographic a picture of the United States. You can pull up your state and see what's available. Nothing you got to consider is your child's age. And college timeline, like I said, the sooner you start, the sooner you start building that habit, the better off you're going to be. You've got to look at your risk tolerance, just like with anything else.

You've got to find what works best for you. And last but not least what I have on my action. Step number four. Review potential tax benefits in your states because like I'm in Delaware, Delaware doesn't necessarily offer a tax benefit, but just down the road to the south, Maryland actually does. And you can take a tax deduction on your Maryland state income tax return for putting money into a 529 plan.

So talk with a professional and look at your individual state and see what's going on. Now tomorrow, I'm going to be discussing 7 alternatives to buying a home in your golden years. So make sure you tune in for that important topic. I'm going to talk about some of the stresses that some older folks go through and not, not just older folks, people in their fifties, sixties. As they're trying to decide, what is their retirement going to look like?

Are they going to have this big home? Are they going to be able to travel? What does that look like? Are they going to be worried about maintenance and repair expenses? So make sure you check it out tomorrow. Now remember. My passion is to help you achieve financial success. I want to see you live out your dreams.

I want to see a grow in your faith. That's why I do what I do. That's why I turn on this microphone. I turn on this camera, playing out these episodes because I want to see you live out your dreams. I want to see you grow in your faith. This is my mission field. This is what I'm passionate about. And I know this together, working together, we can master your finances from that Christian perspective. So as I always end the show, stay financially savvy out there and above all else, may God bless you abundantly.

Narrator
00:23:24

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