My favorite was Oreo.  In her last year, she would curl up in the bend of my elbow and lean her soft, warm, little body against my rib cage, and I would stroke her back and her head for sometimes up to an hour.  Sounds kinda sweet, doesn’t it?

The 529 Is Not the Perfect Pet

Like pet rats, the 529 plan is billed as a perfect investment.  Put in after-tax money, let it grow tax-deferred, and if you pull money out under prescribed rules, the withdrawals are tax-free.  You probably know someone who had a great experience with one.  What’s not to like?

Problem is, you don’t know until you’re knee-deep into the commitment.

Here’s what’s not great about pet rats:  The cage will take up more space that than you care to relinquish, their urine and feces still smells, cleaning the cage takes up a lot of time, the kids likely won’t help like they promised, and vet visits are pricey if you can even find a vet who can treat a sick rat.

Here’s what’s not great about 529 plans:  Just because you funded one doesn’t mean your kid goes to college, you can typically only change investment options once a year, it will likely not cover all of the college costs, and spending the money on the “wrong” things costs you penalties and possibly higher taxes.

For you, the 529 cage might be the wrong size, smelly, and your kids may be no help at all.

Alternatives to the 529

I think what people like about the 529 plan is that it is money specifically set-aside for college.  There’s something mentally appealing about the segregation, and it’s harder to raid the funds in a weak moment when it has little Lizzie’s name on it.

But there are lots of other ways to accumulate assets that can be psychologically earmarked as a college fund:

• A stock/bonds account that can be later transferred to a child to pay for college or pay off student loans.
• Real estate is hugely popular, especially if purchased before a child is born or is very young. Use the rental income or sale proceeds to pay for college.
• Being self-employed and employing your child during the summer has wonderful tax benefits for college funding.
• Some retirement plans allow for withdrawals for college expenses without penalty. You can fund these for your kid if they work while in K-12 and have earned income.

This list goes on.

The 529 is not the be-all-end-all of funding a college education.  If you are going to use one, be judicious about how much you put into it.  While the rules around 529 money have changed over the years (you can even fund a Roth with them now under the right circumstances), the last thing you want is money earmarked for college that will never be used for such.

Focus on the Outcome You Really Want:  A Happy Kid

We loved our rats, but in truth, what we all really wanted was a dog.  At the time, I was unwilling to take on the responsibility or the commitment.

What you probably really want is for your kid to grow up to be successful, confident, resilient, financially self-sufficient, and happy.  College may or may not be part of that path.

I suspect that what you really want for yourself is to grow up to be funded for retirement, confident, financially self-sufficient, and happy.  Flexibility and options are key, and the 529 doesn’t have much flexibility or options.  Choose it wisely.

If you want to talk more about college funding, please reach out.

Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Remember that taxes do good things and you do have choices

First, breathe.  Lighten up.  We’ve all been there in one year or another.  Find gratitude.  The taxes you pay do good things – libraries, schools, roads, people to fix the roads, street lights, police, courts, and the list goes on.  These things may not be perfect, but for the most part, they’re functional.

Second, remember that you have choices.  Here’s something else a bunch of you did this tax season:  You funded your qualified retirement plans.  When you looked at the difference in your tax bill based on whether you funded that plan or not, it felt like a no-brainer to fund it.  You thought, “Look at all the money I saved in taxes!”  You probably thought with pride, “I put money away for retirement just like I’m supposed to and look at how much I put away!”

If you had these thoughts, I want you to contemplate these thoughts:  (1) If you believe taxes are going to remain the same or go down for you in retirement, it makes sense to fund qualified plans.  But if you believe taxes are going up, you’ve just “kicked the can down the road,” when taxes in retirement will likely be much higher.  Did you really save money?  Frankly, taxes are on sale right now.  (2) You may have been better off funding a tax-free retirement with after-tax dollars, rather than a qualified plan, so that when you go to retire, you’ll have fewer taxes to pay, less fear about tax deadlines, and a simplified tax return.  Starts to make retirement look even better, doesn’t it?  Remember that you have choices about how you earn, invest, and spend your money.

Reasons to Use an HSA

While it takes a bit of time to get the hang of how to use the plan, once you understand it, it’s not a big deal.  Complain, consternate, and confabulate all you want about national health care and the lack thereof.  In the meantime, if you’re self-employed, consider an HSA.  Look at these statistics, as provided by my account holder:

• People enrolled in HSA-type plans spend 5% to 10% more on preventive care, have 5% to 10% lower emergency room utilization, experience 10% lower medical costs, and are much more likely to use online health tools.  (Source:  Aetna national survey, April 2010)

• In a study of 2 million members enrolled in HSA-type plans, Cigna found that members used more generic drugs and that medication compliance improved while costs decreased. They also received recommended care at similar or better compliance rates. Members with chronic diseases such as hypertension, joint disease and diabetes experienced between 15% to 27% reduction in medical costs. (Source:  Cigna study, January 2010)

HSA-type plan enrollment has increase 25% from January 2009 to 2010, and most of the enrollment was through employer-sponsored plans.  Why?  Because they’re cheaper for the employer, they give the employees more flexibility (which is seen as a huge benefit), and employees are healthier and at work as a result.

If you want to explore how an HSA might work for you and need a referral, give me a call or send an email. I’m happy to help.

If you’re wondering if your taxes will go up…

Here’s a short list of what expires on January 1, 2011:

1. Personal income taxes will increase:  10% to 15%, 25% to 28%, 28% to 31%, 33% to 36%, and those in the 35% bracket move up to 39.6%.   Remember, that’s just a federal hike. State taxes get put on top of that.
    
2. The “marriage penalty” will start from the first dollar earned.
    
3. The child tax credit drops from $1,000 to $500 per child.  The dependent care and adoption tax credits are reduced.
    
4. The marriage deduction reverts to the single deduction amount.
    
5. The “death tax” returns, with the top tax rate on estates over $1 million going to 55%.
    
6. The capital gains rate increases from 15% to 20%.
    
7. The dividends tax increases from 15% to 36.9% (and another 3.5% increase in 2013 for healthcare reform).
    
8. If you make an early, non-medical withdraws from a Health Savings Account, the tax increases from 10% to 20%.
    
9. Tax benefits for education tuition and fees will not be available.  Tax credits for education will be limited.
    
10. Teachers can no longer deduct classroom expenses.
     
11. Employer-provided educational assistance stops.
     
12. Many families will no longer be able to deduct student loan interest payments.

With Medicare and Social Security in trouble, a war on terror, and an aging population, I can’t see taxes going lower. What does this mean for you?  Maybe it’s time to start looking at saving strategies that allow for tax-free growth and tax-free access.

Suggestions for managing bills and cash-flow

I’m a big believer in keeping as much cash at your disposal as possible and paying government entities on-time, but not early.  No sense in giving someone free use of my money, especially if I might not owe as much as I’m predicting.  How to do this is always the challenge.

First of all, there’s nothing worse than surprises, so eliminate them.  Be in conversation with your accountant at least three times a year (March, June, and December, if not also September) and talk about your income, how much you’re paying in taxes (whether that’s per paycheck or quarterly payments), what your projections are for the year, and what big expenses you may have this year.  That way, if you can adjust your quarterly payments so that they’re more in line with where you will end up at year’s end, the last check is smaller to write.

Second of all, create an account that is devoted to saving up for those “big checks” that happen annually or semi-annually or actually fund them.   Set aside money for property taxes, go ahead and fund your Health Savings Accounts, and your retirement accounts.  Get that money working for you.

Finally, if you’re behind on payments, create a debt repayment schedule and stick to it.  Throw as much money at those debts as you can so you can get in “real time” on your payments.  Sometimes just having a plan will make you feel more in control and capable.

Reasons not to use a 529 plan

1. If you’re underfunded for retirement, you can’t afford it.  You can borrow to send your kids to college.  You cannot borrow for retirement.
2. Not all state plans are created equal.  You have to do your research and you have to keep an eye on fees and investment choices.  States can change their plans.
3. You’re opening another (many?) accounts.  That typically means more fees.
4. If your kid doesn’t go to college, you have to change the beneficiary of the account and that person must be related to the kid.
5. Most investment options are subject to market fluctuations and if your kids are close to college age, you probably can’t risk that much volatility.
6. Any 529 plans in your name count on the Free Application for Federal Student Aid, or “FAFSA” form, which is the standard form at most schools for applying for student loans.  This may limit your ability to borrow since the school will see that you can afford to pay.
7. That same FAFSA form is also used by schools to determine who will get scholarship or endowment money that never needs to be paid back.  Imagine your kid going to college and someone else paying for it.  The fewer assets you have to disclose on the FAFSA, perhaps the better.
8. Life happens.  What if you need that money for other things?  Taxes and a penalty for withdraw for non-educational purposes.

Who should fund a 529 plan?

This is a no-brainer strategy for folks who are well-funded for retirement, committed to paying for their kids’ college education (no loans, no scholarships), and are certain that their kid or grandkids will go to college.  Oddly enough, the wealthier clients that I meet who can afford to do this have been advised against it by other planners.

Other options?

If you want a 529 plan, consider having your parents open it up.  You can contribute, but you don’t control it.  If you’re an employee, consider creating a retirement plan for yourself that allows you to access the assets tax-free for college educations. If you’re a business owner, consider doing the same and/or creating a welfare benefits plan for your business.  In both of these instances, the money you are saving could be—but is not required to be—used for college expense. If the money is not used for college, it can serve other purposes in your life.

What does this mean and why do you care?

Warning:  Remember, this is a blog.  The goal here is to present the big picture on sometimes complicated subjects. By design, I oversimplify.

First, it will likely mean higher rates.  Mortgage-backed securities have bond-like quality.  They sell with a price (what they cost) and a yield (what they earn).  The law of supply and demand drives price and yield.  Sorry to haunt you with Economics 101. If prices are high, the yield goes down (which generally drives people to sell).  If prices are low, yield is high (driving people to buy).  If the Fed stops buying those securities and there is no other buyer, prices will drop to attract those buyers, yields will go up as a result, and those yields are directly correlated to mortgage interest rates, which means—you guessed it—that interest rates on mortgages have to go up as well.  Got it?

Second, understand that just a few years ago, the Fed owned no MBSs.  None.  By March, it will own $1.5 trillion.  Trillion with a T.  This means that $1.5T is now in the marketplace.  Too much money in the marketplace can mean greater inflation (too much money chasing the same amount of goods).  Now, so far, we haven’t seen greater inflation.  It’s the Fed’s job to keep that in check.  Someone also has to pay for these purchases, meaning that the American taxpayer is likely going to have to pony up money to cover it.  That may mean higher taxes—higher income taxes, higher capital gains taxes, and the list goes on.

We can’t predict the future, but we can do our best to anticipate what might be coming around the blind curves in the road.  This might be a good time to consider refinancing into that 30-year fixed-rate loan if you haven’t already.  This might be a good time to consider a loan modification.  This might be a good time to consider retirements and education funding plans that provide a tax-free component.

There’s an Alternative Worth Considering

Roth IRAs have two big downsides:  (1) you can’t access the money without penalty until you’re 59 and a half or have special circumstances; (2) the income limits for contributing to a Roth remain intact ($120K for single filers, $177K for married couples in 2010); and (3) the amount you’re able to contribute is low ($5K; $6K with catch-up).  We get this one-time shot at converting to a Roth, but for many of us, we’ll never be able to contribute another dime to that account.

But what if you could?  What if you could put 10 or 20 percent of your income (an amount that might actually get you through retirement) into an account that would grow tax-free, would allow you access the cash tax-free for any reason at all at pretty much any time, would never require you to take a required minimum distribution, and would transfer to your heirs income tax-free?   Would you do it?  You’d sure like to know about it, right?  It exists.  It’s out there.  It’s likely available to you.

Here’s another issue:  If your IRA accounts are a small portion of your overall net worth, it actually might make a lot of sense to leave it alone and let it grow.  If it’s one of the few places that you’ll withdraw taxable income in retirement, you may be financially better off leaving it in its Traditional IRA form.  Take the tax savings and invest it.

Thanks!