Now what?

When it comes to saving for education, a 529 plan is a powerful tool. Yet, understanding how to fully utilize the benefits of this plan can be challenging, especially when circumstances change, such as receiving a full-ride scholarship or getting into a school that is way more expensive. This guide will help you navigate your options, from qualified expenses to transferring the plan or even converting it to a Roth IRA.

529 Money Goes Only Toward “Qualified Expenses”

A 529 plan allows you to put after-tax money into an account, have it grow tax-deferred, and pull it out tax-free so long as you spend the money on qualified higher education expenses.  Spend it on something else, and you risk paying penalties and taxes on those withdrawals.

A “qualified higher education expense” is defined by the tax code.  The following qualify as a higher education expense:

• Tuition: The school publishes the amount for the school year.
• Room and Board: If the student is enrolled at least half-time.
• Mandatory Fees: All fees required for enrollment.
• Books and Supplies: Materials necessary for coursework.
• Technology: Computers and internet access if primarily used for studies.

But what about other expenses?  For instance, what if you have to fly the kid back and forth to school from home?  Airline tickets are not qualified.  That comes out of your personal spending. Use your 529 money for that?  Taxes and penalties.   

(As a side note: federal law also allows you to use 529 monies to pay for K-12 education up to $10K a year per student without paying taxes on the growth.  This is not the subject of this article.  Note that not all states have mirrored this federal law and as always, you should consult with your tax professional before withdrawing funds.)

Managing Withdrawals: Avoiding Penalties

Paying penalties on top of taxes is no fun, so be mindful about your 529 withdrawals.  Non-qualified withdrawals from a 529 plan are subject to a 10% penalty and taxed at ordinary income rates.

Keeping meticulous records of these expenses is important to stay compliant with IRS regulations.

• Document Withdrawals: Each year, you’ll need to report 529 plan distributions on your tax return, which requires accurate categorization of these distributions.  Keep detailed records – invoices, receipts, etc. – of all withdrawals and the reasons behind them. When it comes to IRS and record-keeping, more “paper” is better than less. When in doubt, keep the document.
• Separate Expenses: Ideally, ensure personal expenses are not mixed with educational ones.  In other words, the laptop is educational, but it should not be on the same credit card as the plane tickets.

In a perfect world, you would have your 529 plan send money directly to the school itself.  Not all plans or schools are set up for this, however, so make sure this is possible and you understand how it works.

If you plan to reimburse yourself for educational expenses, make sure that the amounts you have withdrawn match precisely the amounts you spent.  Otherwise, the IRS has the ability to claim that none of it was for educational purposes.

Some clients love getting perks on their credit cards and educational expenses are a great way to rack up points.  If you choose to pay educational expenses on a credit card, I highly recommend you get a card specifically for this purpose so that nothing but educational expenses show up on it.  That way the IRS can’t argue that some of that money you used to reimburse yourself was for non-educational expenses.  This may feel like overkill perhaps, but so is paying penalties.

(As a side note: if your child receives a scholarship, you can withdraw up to the amount of the scholarship without incurring the 10% penalty on the earnings, though taxes on the earnings will still apply.  Again, always consult with your tax professional.  Again, this is not the focus of this article.)

What to Do When a 529 Plan Doesn’t Cover Everything

Not all families will find that their 529 plan covers all education-related expenses. Here are some considerations for managing these situations:

1. Spread the Funds Over Four Years

One approach is to spread the funds out over the four years of college. For instance, if the 529 plan has $100K in it and the cost of education is $50K/year, you could use $25K/year of 529 money toward the expenses.

This allows the remaining funds in the plan to continue growing tax-deferred, potentially providing more resources over time. This method requires careful planning to balance the use of the 529 funds with any loans or other financial aid received.

2. Use All the Money in the Early Years

Another approach is to deplete the 529 monies quickly.  Using the example above, you would use $50K of 529 money in the first and second years so that the balance of the 529 account is zero by the third year.  

The upside to this strategy is that you don’t have to borrow money in those early years and accumulate interest.  However, if you have to borrow money later, interest rates may be higher or loan terms may be different.  

One downside is that you are potentially giving up the loans for students in those first two years, which are at a lower interest rate.  And, if your student chooses not to continue college after two years, you have nothing left in the 529 should that student choose to go back to school later.  

3. Balance Funds Between Siblings

If you have multiple children, you do not have to use the money in the 529 plan for the child who is the current beneficiary.  You can change the beneficiary and use the money for another child.  

Maybe your older child gets a scholarship but your younger child might end up at a more expensive school.  You can use some funds for the older child and designate the remaining amount to a younger sibling. This allows the funds to continue growing and be available when the younger child needs them. The flexibility of 529 plans allows for accommodating several family members. 

What to Do When You Have Extra Funds

When your child receives a full-ride scholarship, you might find yourself with excess funds in the 529 plan. Here are several options to consider:

1. Graduate School and Future Education

If your child plans to pursue graduate studies, the 529 funds can be used to cover those costs. The rising cost of higher education often makes having a financial cushion advantageous.

2. Transferring to Siblings or Relatives

One of the great benefits of a 529 plan is the flexibility to change the beneficiary. If your child doesn’t need the funds, you can transfer them to another family member. This could be a younger sibling, a cousin, or even a parent returning to school.  Be sure to ask your tax professional about the implications of changing that beneficiary if you’re changing beneficiaries that are in different generations on the family tree.

3. Rolling 529 Money Over to a Roth IRA

Converting a 529 plan to a Roth IRA is another option recently enacted by Congress, although it comes with specific conditions:

• The 529 plan must be at least 15 years old.
• The funds must have been in the beneficiary’s name for the entire period (although the IRS might provide other guidance).
• Only money that has been in the account for more than five years is eligible for withdrawal.
• Only $35,000 can be converted from the 529 to the Roth IRA.

There are also some “unknowns” that may be tested by this law:

• Funding a Roth typically requires the owner to have earned income.  This rule may require that your student have earned income to convert 529 money to a Roth IRA.
• As suggested above, the money might have needed to be in the beneficiary’s name for the full 15 years.  As such, it would be wise to keep money in 529 plans exactly the way you have them until the IRS issues further guidance.

This option repurposes the savings for long-term benefits and retirement planning, offering a valuable alternative if the funds are not needed for education.

Fully Utilizing Your 529 Plan

The big takeaway here is that you have options with the 529 money.  Rather than view your 529 plan as an education funding tool, think of it as a wealth building tool.  You can send a kid to college and arguably increase their earning potential, but you can also use the 529 to further their retirement plans, build intergenerational wealth, or help other family members succeed.

By understanding the nuances of managing a 529 plan, such as using funds for graduate school, transferring the plan to another family member, or even rolling it over to a Roth IRA, you can increase the chances that your savings works effectively for your family’s future. 

Understanding these options and making thoughtful choices increases the potential of your 529 plan money. Partnering with financial advisors like Lanning Financial can provide the expertise and support necessary to help you make the most of your 529 plan funds, using every dollar wisely and efficiently for your family’s future.

If you would like to talk about your 529 options, please get in touch at (415) 354-5699.

To review, you should start giving your children an allowance as soon as they can count money, usually at four or five years old. Your sole purpose in providing an allowance is to give your children an opportunity to build money skills. Allowance should not be tied to chores. They get an allowance because they’re part of the household; they do chores because they’re part of the household. When it comes to allowance, you get to make the rules and enforce them. You may have values about money that you want your kids to learn. I’ll share what has worked in my house for years.

My son and daughter get an allowance every week, like a paycheck. They receive a dollar for every year of their age — at age 7 they get $7, at age 9 they get $9, and so on. This may seem like a lot of money. Keep reading.

From that amount, my kids are required to give 10%  to charity and put 20% in long-term savings. They get to spend the remaining 70% pretty much as they wish. They have individual places to put this money. For years, we used a divided piggy bank. Coffee cans work just as well. Now we use storage containers. Every week they get an envelope with all their money with the denominations available to make the allocations. You’ll need to help them when they’re young to count and sort the money — it’s a great coin identification and math exercise.

An important note: Make sure they physically handle the money, especially when they’re young, and make them count money when they pay you back for something you bought for them at the store. You want them to have a real life experience of receiving money and watching it leave their hands. We handle actual money so rarely in our society these days. For the longest time, my kids thought that if you needed cash you just went to the ATM and got some. They had no idea that you had to put money in to get money out. So make this reality of having money come into their possession and leave it a part or your kids’ early lives, so they can transfer that experience to the non-cash-oriented world when they’re older.

With all that cash burning a hole in their pockets, sooner or later your children will want to go shopping. Take them, allowing for a significant amount of time to shop, especially early on. You want to make sure they have time to walk all the aisles, pick a variety of things, put them back, choose something else, etc. But leave their money at home. Pay for their purchase yourself, then have them pay you back when you get home. This avoids a lost money crisis and allows for experiences with sales tax, how credit cards work, paying someone back, making change, etc.

Here’s the real trick:  Do NOT judge what they buy. You can set rules and constraints, but after that, hands off. For instance, I didn’t allow my kids to buy toy guns or candy. Sometimes I will put the kibosh on yet another oversized stuffed animal. After that, they can pretty much get whatever they want. This will take much discipline on your part, but I promise it will be worth it.

This plan has incredible beauty that I never saw coming. More on that next time. In the meantime, get your envelopes ready!

The financial planner in this story goes on to explain to his fellow passenger that it’s not the money you need to pass down, but the skills and values that have helped you build wealth. Money can disappear overnight, especially in the hands of those who have no skills to manage it. The old adage applies: Give people a fish and they will eat for a day. Teach them to fish, and they’re fed for life.

I’m a huge advocate of giving children an allowance for this very reason. As a general parenting philosophy, I believe it’s important to let kids have age-appropriate opportunities to screw up when the stakes are low. Direct experience and its consequences are the best teachers. I’d rather my daughter learn that it’s not such a great idea to put the heaviest block on the top of the tower when she’s three years old than wait until she’s 15, when I need her to stack the dishes in the cupboard. It’s the same with money: You want your kids to learn early.

Here’s another belief of mine: We don’t know what’s “sticking” in our children’s brains. Think about it. Memory is such a subjective and selective thing. Almost everyone has a lesson they learned about money that stuck with them. Most of us heard a parent or influential adult say something about money that influenced our beliefs about it, like “money doesn’t grow on trees.” The best thing you can do for your kid(s) is to let them have lots of opportunities to form their own beliefs about money — for example, not spending more than you have, avoiding deficit spending, delaying gratification — so they can form good money habits early. These are crucial life skills, and they don’t get built through our lectures.

I don’t claim to be an expert in this area. Most of my training has come from financial counselor Kathryn Amenta and from my son and daughter, who have been receiving an allowance since the oldest turned five. I encourage all my clients to give their kids an allowance, even if they are much older than that. Better to learn hard money lessons as late as college than when they get their first real paycheck.

How to make it work? Stay tuned.

Pick a date!

You can’t predict the future, but you need to start somewhere. Retiring at 65 is no longer the default. Your target age should stem from your values, so revisit or define them.

Ten years out

This is a time to get a reality check on your financial life and start to envision what retirement will be like.

• Time to take a basic retirement planning class. Look to your local community college, retirement system pension planners, or professional organizations. You’re not trying to become an expert or nail down your plan. But you are trying to figure out what you need to know and what you need to think about.
• How much money have you saved in a 401(k), 403(b) or other retirement account?  Do you need to save more?  Will you need to work longer?  Do you need to adjust your allocations to make them more aggressive or (more likely) conservative
• Will you get a pension? When will you reach the vesting requirements?  How much will you receive? How will it be paid out? In a lump sum, monthly, etc.?)
• Do you have a copy of your Social Security statement? How much can you expect to receive?
• What other assets and investments can contribute to your retirement? Are there any potential drains on your income?
• Start having conversations with your close friends and family members about your vision for your “retirement.”  How do you want to spend your time?  What skills might you want to keep using in part-time or volunteer work?

 Five years out

• Revisit the questions from 10 years out.
• This is a good time to start a journal. Take some of those daydreams you put away and make them more specific. For example, rather than “spend time with grandkids,” you might write “spend two dinners a week with grandchildren.”

 Two years out (or less)

Time to get serious.

1. Make sure your partner/spouse is involved, if you have one and they aren’t already. Communicate and negotiate with them about how you expect to spend your days and money.
2. Hire a financial planner if you haven’t already done so. You want a fiduciary. The Financial Planning Association is a great place to find one.
3. Create a realistic budget. Figure out if you’ll need to work for income or where you may need to cut back on expenses.
4. Figure out when you’ll take Social Security, whether and when you will sign up for Medicare, etc.
5. Turn that “stake in the ground” into a real retirement date. Put a date in the calendar to retire, whether you share this with your employer or not.
6. Get more specific about how you’ll spend your newly found time.

 I often say it’s not about the plan, it’s about planNING. Life happens. Mid-flight corrections are necessary, and you can’t schedule those.  But following this schedule will help minimize the changes and the surprises.

Take the pressure off!

You do not have to have all of the answers now, so start by separating the financial part from the how-to-pass-the-time part. I often tell clients who are “stuck” on how to begin planning for retirement to focus on the first three years and then on the last three years. This takes the stress out of a big question like, “What the heck am I going to do for 20-30 years?!”

For the first three years, write down the collection of projects you want to get done. This often leads to a very satisfying feeling of purpose and direction. It’s like you’re still working, but you’re working on the stuff you want to work on and have been putting off. I’ve had clients travel for a year, remodel homes and take care of grandchildren, to name a few.

Then write down your ideal last three years, which are also usually easy to envision. These are typically slower, easier, quieter. This part also comes with specifics, such as:

• where you’ll live,
• who you’ll rely on for companionship and support,
• how you’ll want to manage your physical slow-down,
• how you want to be cared for and who will take care of you, and
• how you’ll feel at the end of each day

This process helps you figure out how much money or assets you need to set aside to meet these criteria, which will help build the financial part of your retirement plan.

Now for the years in between. I recommend making a list of the skills you want to keep using. This will likely have far fewer specifics than the first or last three years. That’s fine. For instance,

• I’ve had teachers that want to continuing teaching, so they consider tutoring.
• Those leaving executive positions find there are all kinds of nonprofit boards looking for expertise in leadership, development and managing a budget without having to manage employees.
• Some people enjoy mentoring others and find places to create those relationships.
• Talk to others who have retired. Keep your networks going with people who are or are not in the workforce. You don’t need to know exactly what you want to do, but it’s helpful to identify those skills of which you are most proud, most willing to “give away,” and most likely to energize and satisfy you.

In my experience, most people take two to three years to settle into a “retirement groove.” They tackle all of their projects early on, then they hit the end of that list and it takes a while to figure out how to spend their days. Even those who have done a “whole lotta nothin’” in the first year of retirement realize they want to make a change in how they spend their time. This is typical and normal. I also find it takes two to three years for the budget to work itself out. Rest assured, both how to spend time and how to spend money do work out. And both begin with figuring out how to spend the first three years and how to spend the last three years.

You can buy a house and you can get a mortgage

Here is what we have been able to do in the mortgage world lately:

• More and more lenders are making appraisals easier.  We are able to use AXIS appraisals, which are based in the Bay Area (fewer Fresno- and Martinez-based appraisers doing appraisals in San Francisco).
 
• We have a lender that will do 90% loans to $979,750!!  That means we can do a purchase of a $1,088,000 home with 10% down.
 
• Rates are still low.
 
• Lenders are still lending on live-work lofts.
 
• Lenders are still doing recent condo-conversions (TICs to condo).
 
• We have lenders that will still fund in the name of an LLC or corporation.
 
• We have two banks that will underwrite and approve a borrower based upon his/her assets and derive an analytical income for qualifying for the loan versus using income derived from tax returns.  This is like a stated-income loan for those with lots of liquid assets.
 
• We have banks that will allow for a community second mortgage or an employer second mortgage, such as the SF Mayor’s Office of Housing program or Kaiser employee loans.
 
• Most condos can be FHA approved by sending in FHA approval packages to the California office or HUD.  Turn-around time is 2-4 weeks.

The rest of the market?  Just as tedious as it’s ever been.  If you have to get a mortgage, hang in there.  The paperwork is oppressive and the conditions are often silly, but it will happen. Call us if you need some help.

A little education can go a long way

It should be no surprise to you if you’re following this blog that I’m not a fan of 401(k) plans.  Most of my clients have them, though.  They need help identifying the best funds, and they need a way to manage those funds.  As you also have probably gathered, I’m a big fan of not losing money and taking advantage of opportunities to make money. 

Time for shameless self-promotion.  If you want to know if you’re in the best performing funds in your 401(k), and if you want to have some guidance as to when you should be taking advantage of the best times to make money in the markets, you ought to check out this tool:  http://lanning.mutualfundmarketalert.com/. Please fill out the sign-in form and watch the video.  I don’t spam.  I don’t sell my database to anyone at any time for any price for any reason.  You may have limited options with your 401(k).  The least you can do is make the most of them.

Put your attention on your weekly money

What you want to do now is physically separate your money into different buckets.  Here’s what you do next:

1. Set up multiple accounts at your bank.  Most of the bigger institutions will let you set up multiple accounts for free if you automatically transfer money into them each month (which you will).  Nickname these accounts.
    
2. The first account is your “static account” (call it whatever you want).  All income is deposited here.  Leave money there to meet static expenses.  The rest gets transferred to your “discretionary” accounts and your “savings” accounts.
    
3. Only money for the week gets transferred from the static account into the discretionary account.  Make an agreement with your financial partners (if you have them) as to who is going to get how much.  Each person should get a debit card.  Each person spends that money through the debit card. No credit cards.  Pay your static expenses with a credit card if you want the miles. Use the static account to pay off the credit card, but ONLY for those expenses.
    
4. IMPORTANT POINT:  Get enough money only for the week.  Not the month.  If you spend all your money by day 5 of the week, you can limp along for two days without money.  But if you run out of money on day 15 of the month, two weeks is too long to go without money.  Putting your attention in weeks also helps you focus on what you’re doing.  You will be more present.
    
5. Transfer money automatically each month into your “vacation”, “kitchen remodel”, etc. accounts at a set amount (nickname the accounts as such).  For instance, $50 into the vacation, $200 into the kitchen remodel, etc.
    
6. Watch what happens.  

Here’s what I hear from people who have actually done this:  People start to turn it into a game.  They start to see where they could reduce their static expenses.  They start to contemplate whether they really want that new grill (or purse or pair of shoes) or if they’d rather add that money to their “kitchen remodel” account.  They watch their static expenses shrink, they get more present with their decision-making around the discretionary money, and they love to watch their “kitchen remodel” accounts grow.  It’s a game. It’s fun.  It requires little accounting, as most of it’s done automatically.  You don’t have to watch every penny.  You don’t have to know how to use Quickbooks.  Brilliant.  If you have success, I would love to hear your stories.

For many, this strategy isn’t working, either right now or ever.  Those folks need to watch where their money is going.  I’ve long believed the trick to getting started, leave alone getting it right, is to make it easy and fun.  I think I might have found it.  Now, I stick to my inclination not to work with folks on budgeting, bail-outs and bad attitudes, but I’m always willing to share strategies that work.

Think of your money in three buckets—static, discretionary, and future

I will start with an admission:  I don’t actually budget the way I’m about to describe.  I’m stealing this idea from a Financial Planning Association conference I just attended (my whole life is continuing education).  I’m one of those freaky people that keeps track of just about every expenditure, tracks it in Quickbooks with help of my assistant, and analyzes where money is being spent, where it can be saved, etc.  Most people won’t do this, so I rarely, if ever, recommend it. 

What I like about this idea is that it’s easy and fun.  This step should take no more than an hour.  Here’s what you do:

1. Get out the last six months’ worth of statements that contain your expenses (checking, credit cards, etc.).  Six months is required for homeowners, in particular, so it catches semi-annual expenses.  You might want to add other annual expenses.
    
2. Add up all the expenditures and withdraws (ATM withdraws included). Divide by 6.  This is what you’re spending per month.
    
3. Now, go through those statements and identify all your “static” expenses – that is, those that happen every month as a result of passed decisions you have made.  Those expenses include the mortgage(s), property taxes, insurances, car payments, utilities, other loan payments (including credit card interest), childcare expenses (not random babysitting), etc.  Add them up.
    
4. Everything else is discretionary.  Subtract “static” from total expenses.  Remember to keep your timeframe to monthly numbers.  That’s your discretionary budget.  Divide by 4.5 (or so).  That’s your weekly discretionary budget.
    
5. Now sit down and decide what you want or need to save for.  These things could be a kitchen remodel or new clothes or a vacation.  Some folks will add to this quarterly tax payments or annual payments like life insurance premiums.

Here’s what you’ve done.  You’ve gotten a clear picture of how much money you are spending as a result of passed decisions.  That’s your static bucket.  You’ve gotten a clearer picture of what you’re spending week-to-week on food, clothes, household goods, extra babysitting, pet expenses, etc.  You’ve gotten clear about what you want to do with your money. This may take some tweaking along the way, but you’re on your way.  See next week’s post on what to do next.

You can have confidence managing your 401(k)

When I meet my clients with 401(k)s for the first time, most of them have no idea why they chose the funds they did, have no idea whether they’re in the right funds, and have no idea what to do next. So they have done nothing for years and are continuing to do nothing. This does not have to be you. Here’s a game plan for you:

•   Get out your last statement.  Since it’s not been so scary to open it lately, you might actually know where it is.  

•   Check out:  http://lanning.mutualfundmarketalert.com/. It’s the best tool I’ve seen so far to make managing a 401(k) easy.  It’s an educational tool. That’s all. But it might help.  

•   When I tell clients to talk to their 401(k) administrator about their plan, I get either a blank stare or the somewhat rhetorical questions, “yeah, who is that?”  Your company does have a 401(k) administrator somewhere.  Find that person.  

•   Ask the administrator these questions: 
     o   May I please have the list of funds in which I can invest?
     o   How often can I change my allocation?
     o   How do I change my allocation?
     o   Are there any penalties for changing allocations?  

•   Implement the Mutual Fund Analyzer tool. Follow the signal. Make your adjustments. 
 

This is simply an educational tool that might allow you to catch the upsides of more of the markets. You won’t catch the highs and you won’t necessarily miss the lows.  But that’s better than blowing with the volatile wind of this bear market.  And, if you can make some money in the meantime, all the better.