NerdWallet's Smart Money Podcast - Unlock the Benefits of 529 Plans to Save for College Tuition and Education Expenses

Episode Date: February 26, 2024

Learn how to utilize a tax advantaged 529 plan to help your or a friend’s children save for future education expenses. 00:57 This Week in Your Money: What are the risks of purchasing a home without an inspection? How can you plan for major expenses when healthcare providers can’t tell you how much their services will cost? Hosts Sean Pyles and Sara Rathner share their hot takes on unexpected financial challenges, with tips and tricks on handling surprise expenses, understanding the importance of home inspections, and dealing with healthcare industry inefficiencies. 09:46 Today’s Money Question: What are the benefits of a 529 college savings plan? Can you contribute to a friend’s 529 plan to support their child’s future? NerdWallet writer Elizabeth Ayoola joins Sean and Sara to discuss the essentials of 529 college savings plans. They discuss the types of educational expenses covered, the tax benefits associated with 529 plans, and the flexibility of choosing different state plans. They also answer a listener’s question about how to approach the sensitive topic of financial gifts for education with parents, sharing methods for contributing to a loved one’s 529 plan without overstepping boundaries. Then, they discuss the implications of the Secure Act 2.0 on 529 plans, methods for estimating necessary savings for a child's education, and tactful ways to discuss educational contributions with parents. In their conversation, the Nerds discuss: 529 college savings plans, financial planning, educational savings, personal finance, budgeting, unexpected expenses, saving for college, tax-advantaged savings, financial gifts, college fund, education expenses, financial pressures, smart spending, investment plans, home inspection, healthcare costs, higher education, financial obstacles, educational funding, educational investments, financial strategies, money matters, budget woes, financial frustrations, financial storms, monetary setbacks, savvy spending, financial goals, state tax deductions, tax benefits, financial contributions, Roth IRA rollovers, financial planning skills, education costs, college tuition, and family finances. To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail]. Like what you hear? Please leave us a review and tell a friend.

Hey, Sean, has money ever made you mad? Yeah, it has, especially when I get a bill that I don't expect to pay, but have to anyway. So yeah, why? Yeah, yeah, those surprise major expenses are a huge pain. I just had to replace my washing machine because the fun never stops in my house. In this episode, we are going to let off a little steam about what makes us mad in the world of money. Welcome to NerdWallet's Smart Money Podcast. Our job today is to help you be smarter with your money, one money question at a time. I'm Sean Piles. And I'm Sarah Rathner. So listener,

this show is all about you and your money questions. So whatever financial decision you're pondering, whatever's making you mad about your money, let us know. Leave a voicemail or text the Nerd Hotline at 901-730-6373. That's 901-730-NERD. Or you can email your questions to podcast at nerdwallet.com.

This episode, Sean and I answer a listener's question about contributing to 529 accounts for your loved ones. But first, we're gonna yell into the void in our semi-regular money hot take segment. So here's how this works. Sarah and I just rail against whatever we feel like in the world of money. And let's put, say, 100 seconds on the clock. That's what, a second for every penny in a dollar? I don't know. It's just an arbitrary number, really. That works for me. It's a nice round number. All right. Sarah, are you ready? Yes. I am starting my timer. Go.

All right. I hate the trend where homebuyers feel pressure to completely waive getting a home inspection before buying a property. That's different from the type of waiver where you'll still do the inspection, but then you're assuming the cost of anything you find. It's when you just do without the inspection entirely. I live in a block of houses that are like 107 years old and two houses on my block sold with waived inspections where the buyers had to put tens of thousands of dollars unexpectedly into problems in their house that they didn't know about. I just had a neighbor text me asking for a roofer because the first time it rained since she moved in her house, it started raining on the inside of her house, which means that the seller

just lived with that for however long before selling the house and passing the problem on to somebody else. So especially if you're a first-time homebuyer, if you are going to drain your savings to buy your house and then you're not going to have much money left for repairs, be really careful about this. And as a society, can we just make inspections mandatory? Like that's more consumer friendly, honestly. People need to know what they're getting into. And frankly, people should feel pressure to keep their houses well maintained before sale. There, I said it. You've got 40 more seconds if you want to keep on railing. Oh man, I do. Well, if you haven't bought a home yet, what's nice about getting an inspector involved is they'll look at all the major systems of the house, the appliances, the roof,

all sorts of stuff, the electrical, the plumbing, and they will tell you the lifespan of some of those major things like a furnace or a boiler, your roof, your HVAC system. And even if something is going to go in the next year or two, at least you have this laundry list of things and when they'll probably need to be replaced. And you can begin to budget for those replacements. Okay, that's 100 seconds. Boom. All right, Sean, you got any reaction? Well, I totally feel that because buying a house without knowing what's wrong with it

is very risky financially. Buying a house can be financially risky in and of itself, depending on how expensive the home is. But imagine getting into the house, it's your first day, you're super happy to be a homeowner, and then you realize, oh, it's raining inside the house, or the crawl space is infested with termites. You don't know what you're getting into

if you don't have an inspection. And even if it may make you a more competitive buyer, it isn't worth it, in my opinion, to get yourself into something like that because you just don't understand the risks you could be taking on. And I'm all about mitigating risks as much as possible. All right, Sean, I have had my turn and now it is your turn. I have set my timer for 100 seconds and go. Okay. Today, I am mad about industries that are designed to extract money from us while making our lives miserable

or at least really frustrating. And I have one, maybe two examples, depending on how far 100 seconds takes me. First up is healthcare. Americans spend far more on healthcare than other wealthy nations. Nearly 18% of our GDP in 2021 went to healthcare. And what are we getting for it?

An incompetent extractive industry that exploits nearly everyone that engages with it. Among wealthy nations, the US has the highest rates of infant and maternal mortality and excess deaths, not to mention the daily indignities that come with trying to access healthcare. And I have a recent example that is a microcosm of these larger issues. So I recently got a bill in the mail for some regular lab work. And the thing is, I have these labs done every few months, and they are always covered by my insurance. But this time, I got a surprise bill for nearly $200. And I'd already had an expensive month with some car repairs, and I was not excited about the prospect of an additional $200 to cover.

So I called my doctor. And they said, oh, yeah, the company that does the lab work just messed up. Oops, just disregard the bill. So if I hadn't called my doctor, I would have been on the hook for this bill. And this was a relatively small bill as far as medical bills go. And it was fairly easy for me to clear up. I'm obviously very fortunate in this case. But for so many people, especially those with chronic illnesses or complex medical conditions, the onslaught of navigating insurance, verifying that you're being billed correctly, and then somehow coming up with the money to cover bill after bill is just totally exhausting and can make achieving financial goals nearly impossible.

So why am I going on and on about things that we already know too much about? Just so you know, you're over time. Oh, God. I'm going to keep going. I'm almost done. Keep going. Let's do this. All right. I am going on and on about this because I think it's important to remind people that it does not have to be this way. And we are in an election year, people. So I don't know. Let's try to do something about it. Okay, Sarah, how many seconds was that? Oh, well, I stopped timing it the second it hit the clock. So that might have been just an extra 10 seconds, honestly.

Okay. Yeah. It's hard to fit so much into such a small amount of time. You know what? Your rage is such that it cannot be fit into a tiny container. And that is valid. It's okay to let the rage out and give it some more space. And I agree with you. And so what's annoying is, for example, I mean, in this past year, I had a baby and that is expensive to the tune for me of $7,000 out of pocket after insurance. Hi, $7,000 is a lot of money, people. And what was annoying about that, and this is something for anybody who maybe is facing like a planned medical procedure, like a surgery or childbirth or anything like that, or who takes medication for chronic illnesses. I tried to call the billing department of the hospital to talk to my insurance company

to say, can you at least give me an idea of how much money I will be out? I knew going into it that I would be having a C-section. So I can say I'm having a C-section. Like that means I have to work with an anesthesiologist, such an extra expense. Like, can you tell me ballpark, even if you're off by a grand, like how much should I budget for this? And everyone's like, we don't know shrug emoji. And then, and then the bills just fly in for months and you think you're done. So you're like, okay, we're done paying for the hospital bill. Now we can like put our money into other stuff. And then you get another bill for like $1,100. Yeah. And you have to question, was this billed correctly? Was it coded correctly?

You don't know. And it just flies in the face of all of the things that we try to talk about in the personal finance space, which is around anticipating big expenses, budgeting for it, saving up for it if you can. It's impossible when you don't know what you're going to be paying. Right. And if you're facing surgery, what, you're just going to not have anesthesia to save money? Like, do not recommend. So that is not a money saving tip that we would recommend. No, no, that's a place where you should spend good money, get good enough. But like, really, it is an extra expense. And that's so, so frustrating, because you are not only out a lot of money, but you're feeling kind of vulnerable because you've

just gone through some medical stuff, even if it's just blood work or something. And you want to take good care of your health. And it's sometimes financially impossible to do that. Yeah. Not to mention completely demoralizing. Yeah. And some people just don't go to the doctor because of the cost or the dentist. And then years later, they're faced with really serious health issues because they've been neglecting their health because of the cost. Yeah. So I don't know. It's really tough in this space to talk about medical expenses because at NerdWallet and in the personal finance realm, we try to give actionable advice. And a lot of the time, the advice is reactive. Like if you get a medical bill, you do have to ensure that it's coded correctly. Maybe try to work out a payment plan with your medical office if you can't cover the bill in one go. But it's so hard to be proactive, like you were just describing and understand what you're going to have to pay if you want a routine procedure like blood work or

something more significant, like having a baby makes me want to yell into the void all day, every day. Yeah, well, we took more than 100 seconds about this. If you have a body, then this is something that affects you. And it is really hard to deal with those extra unexpected costs. All right. So that is what we are mad about this week. Listener, I know there's a lot to be mad about in the world of money. So do not keep it in. Let us hear what you're mad about. And we might just share it on a future episode. So you can text your money hot take to us or leave a voicemail on the nerd hotline at 901-730-6373. That's 901-730-NERD.

Or you can email it to podcast at nerdwallet.com. All right. I don't know about you, but my heart rate is starting to come down from all of that. Deep breaths, everyone. This episode's money question is up next. So calm down too and stay with us. This episode's money question comes from Lauren who wrote us an email. Here it is. Hi, nerdy nerds. I'm not a parent. I'm never going to be a parent. Because of that,

I have made it part of my financial plan to contribute to the 529 plans of kids around me. Because I don't have nieces and nephews, I'm contributing toward the savings of my friend's three-year-old. How much needs to go into a 529 starting at age two or three to cover a four-year private college? I got the details on this kid's 529 plan from his dad and started contributing about $100 a month. We didn't talk about it. I intend to keep chipping in

until the kid is done getting formal education 20 to 25 years from now. How do I talk to the parents? I want to understand if I'm helping enough without becoming privy to their private financial details. I also don't want to make it seem like I have any vote whatsoever in how the kid charts an educational path. How do I broach this with the parents? To help us answer this listener's question on this episode of the podcast, we are joined by NerdWallet writer Elizabeth Ayula. Welcome. Hello and hi. Elizabeth, so good to have you on. So let's start by setting some groundwork.

Can you please describe what a 529 college savings plan is, how they work, and why they're such a big deal? A 529 plan is a huge deal indeed to me anyway. I wish I had one when I went to college because I was left with a huge bill. But anyways, 529s are tax advantage college savings plans, and they allow people to save and invest money for education expenses. So with that said, the money gets to grow and it gets the compound, which can mean beneficiaries have a nice education pot to pull from when they need the money. And for those who don't know what compounding is, it's essentially when your interest earns interest. It's the eighth wonder of the world. Yeah. So you mentioned education expenses, and that's what the purpose of this account is. But what kinds of education expenses can you use a 529 to fund?

So funds in a 529 account can be used to cover a vast range of qualified expenses. And that can range from tuition to computers and education related equipment. The expenses can also be used to pay for education needs of your beneficiaries. And the good thing that I like is that the beneficiaries can be in anywhere from kindergarten through grade 12. So that said, it's not only for college students. Right. That is a really good point because people hear about 529 accounts and they think they may be specifically for people

going through a traditional four-year education, but people can also use the funds in the 529 college savings plan to cover things like trade schools too. So it really isn't only for that traditional four-year higher education route. So earlier you mentioned that 529s are tax advantage accounts. Can you talk a little bit about the tax treatment of them? And what should people know when they're considering opening a 529? Well, one thing that I personally like about these accounts that some people don't know also is that some states offer a tax deduction if you contribute to their plan. And when I say their plan, I mean the state that you live in. But there is no federal tax deduction for a 529 contribution. So it's only at a state

level. The tax deduction is usually capped. So no, you can't just deduct your entire contribution. The deduction amount varies from state to state. So it's best that you check in your state what the amount may be if they offer it. And a little bit off topic, but I also like that the IRS doesn't set a cap on your contributions to a 529 account, although some states do set a limit. And I'll call out two other tax benefits of 529 college savings plans. The first is that investment growth in this account is tax free. And second, distribution for qualified expenses like tuition or books are also tax-free. So Elizabeth, another important thing to know about 529 college savings plans is that each state has their own.

And you don't have to choose the 529 plan from the state that you live in. And this can all get a little bit confusing because there are so many states to choose from. So at a high level, can you outline the main differences between a 529 from one state to the next? And how would someone go about choosing which state's 529 plan to use? One of the major differences that people should know

and a reason that people may cheat on their state's 529 plan is lower fees. I personally have a 529 from a different state than my current home state for that very reason. So people should consider shopping around and comparing fees before opening an account. Ultimately, the goal should be to do some math and see whether the deductions and the credits that you're going to get in the state that you live in are worth more than the lower fees that you could get in another state in the long term. Also note that you can open multiple 529 accounts. I have multiple 529 accounts. I recently opened a second one in my home state, Florida, because my son was awarded a grant and it could be transferred to a 529

account, but the catch was it had to be a Florida 529 plan. So 529s have some flexibility, which we talked about before, not just for four-year educations, but also for trade schools and for K-12 expenses as well. And interestingly enough, 529s were just made even more flexible. Can you talk about recent changes around the ability to roll 529 funds into a Roth IRA and what that means for folks who maybe aren't considering going to college? So the Secure Act 2.0 was recently passed. And if I can be honest, that's what motivated me to open up my first 529 account. And I just opened it last year. I was always on the fence

and only saved money in a brokerage account because I was afraid of what would happen if my son decided not to go to college in 15 years. He's six, by the way. So I decided to get off the fence when this Secure Act 2.0 made it possible for people to roll at least a portion of the unused funds into a Roth account. However, you do have to wait until 15 years after you've opened the 529 account before you can roll those funds over. And you can also only roll up to a certain limit starting in 2024. It may be ideal to read the IRS's rules. You know, they have a lot of fine print around the conversion or speak to a finance professional about it.

I think Roths are also awesome because they aren't subject to required minimum distributions and withdrawals. They're also tax-free when you meet certain requirements like waiting until 59 and a half amongst other rules. All right. Well, thank you for that great summary of the tax rules surrounding this new change. We just want to let you all know that we are not investing or tax professionals. And if you have any specific questions to your own situation, definitely consult a professional who can give you guidance. Now, let's turn to the fun stuff, the math, Sean. I know that you are in the midst of your certified financial planner coursework. I have slogged through that myself. It is a lot. There's a lot of math. It is. And now that you know how to do it, I'm sure you're eager to show off your chops. So are there any insights you can share that will help our listener figure out how much

they need to save every month or every year to help their friends reach their savings goals? As a matter of fact, yes. And you're right. I have been waiting for an opportunity to show off what I've been learning about because often I'm just doing calculations in silence. And this is a time for me to be loud and proud about hitting buttons on a calculator. So let's do it. I'll spare you and our listeners these specifics of the calculation, but I plugged a listener situation into a time value of money calculation and got a rough estimate for how much they will need to save. All right, drum roll. What's the number? For our listener to meet the savings

goal that they outlined in their question, remember they want to save for four years of education at a private college, starting now-ish and saving until the kid finishes school, they would need to save around $8,000 per year. So obviously that's a lot of money to contribute to a 529 account, no less for a kid who isn't your own. And this is why 529s are often just part of the picture when it comes to paying for college, which usually includes some combination of scholarships,

grants, and loans, and generous gifts from family friends. That is definitely more than a hundy a month. So yeah, that's for sure. All right. So all that math out of the way, I want to talk about the other part of our listeners question. They seem to be concerned about how much they should contribute and also how to talk about this with their friends. I am not a parent. So I would love to hear from both of you who are parents, how you would approach the situation if you had such a generous friend, would you welcome the money or say, get out of my business? Or if you are going to accept this money, if you want to have this conversation with your friend, how would you want them to communicate that with you?

Honestly, I would welcome the money, especially because I'm a single mama. So matter of fact, my friends always contribute to my son's savings account in London for his birthdays or holidays, and I really, really appreciate it. It can be a better gift to me than toys that stab me in the foot within a few days. Yeah. I would also appreciate a friend asking me what my savings goals are so they know how to support that goal. However, I do think for the sake of boundaries, I would like my friend to ask me my comfort level with the topic before they dive in and start kind of trying to give advice. And I think it's also important to note that not everyone is comfortable discussing money or financial goals. But with that said, here's an example of maybe how somebody could say it. So you may say, hey, I want to help you reach John's college savings goal.

Are you comfortable discussing that target number you have in mind? And can you tell me how I can support that? Or another option could be you saying, hey, would you like to do the math yourself and then let me know how I can support that goal? So those are just a couple of options. Yeah. I mean, I'm not going to look a gift horse in the mouth. College is expensive now, and it's only going to become even more expensive

in the future. I mean, even in-state tuition where I live in Virginia is often over $20,000 a year. That used to be the economical way to get a four-year degree. And now it's also very, very expensive. And so what's it going to be like by the time my kid's in college? I don't know, a lot. I think we can confidently say more money. Confidently, we can say a whole lot more money. So I would want my friends to decide for themselves what they feel comfortable giving because I don't feel comfortable telling another person how they should allot their money because they have other competing financial goals and obligations. And I never want to tell another person what they can do with their money

unless they specifically ask me to tell them what to do with their money, which nobody ever asks me. And you also don't want to give the impression that your friends can't look after their own family's finances, right? Like that's a bit of the awkwardness underlying the question is you want to help someone that you care about and this child that you're seeing grow up in the world, but you don't want to impose your will upon them. It seems like our listeners being very thoughtful about that. And you don't want to make it seem like you think they aren't doing enough. Right. Or you think their kid should go to a four-year private university because that's what you value, but maybe the parents have other values that they want to impart upon their child as the kid grows up. And then the

kid will go off and do their own thing as a young adult. I mean, in my case, we have a 529 for our son. We have family members who've contributed money. They've just written checks to us and then we deposit it into our account that is tied to our 529 and then deposit the money into the 529. And so ultimately, when you contribute, you do go through the account owners, and that's oftentimes parent or guardians, you are going to have to communicate with them because they're ultimately the gatekeeper of that account. They are the owners and then the child is the beneficiary. And that actually brings up something I wanted to talk about, which is who would own this account. The listener could, in theory, open up a 529 account on their own for this kid. But long term, it's probably going to be easier if the parents are the owners of the account, because that way,

when the kid is eventually ready to go to college or trade school or what have you, the parent can be the one managing those distributions. And personally, I know as a friend, as much as I love my friends and my friends' kids, I don't want to have to manage that down the road. So that's something else that they should think about when they're talking about this with their friends. I definitely agree with talking to the parents and ultimately contributing to an account

that the parents or guardians are in charge of. Well, Elizabeth, do you have any final thoughts around 529s and helping your friends' kids afford college? I think we have given some very juicy tips here and only two more things come to mind, which is one, while it's knowable to contribute to your friends' kids or loved ones' kids' 529 account, please take advantage of any state income tax

deductions that you might be eligible for. The rules around this can be muddy. And I know the original listener who asked this question lives in a different state than where he's contributing, but sometimes you're able to get a deduction depending on the state that you live in. So if you can get money back, I mean, why not? And my second thing that I'll say is that if your loved one doesn't have a number in mind, guide them to a college savings calculator or run the numbers together over a coffee if they're open to doing that. Great. Well, thank you so much for coming on and talking with us. I loved it. Thank you for having me. And that is all we have for this episode. If you have a money question of your own, turn to the nerds and call or text us your question at 901-730-6373. That's 901-730-NERD.

You can also email us at podcast at nerdwallet.com. Visit nerdwallet.com slash podcast for more info on this episode. And remember to follow, rate, and review us wherever you're getting this podcast. This episode was produced by Sean Piles and myself, Kevin Berry and Tess Bigland helped with editing, Sarah Brink mixed our audio. And a big thank you to NerdWallet's editors for all their help. And here's our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.

And with that said, until next time, turn to the nerds.