If you have followed the blog lately, you may know that I’m a soon-to-be dad. Very soon in fact, about 10 days. I’m both excited and a little stressed.
Excited, because of course I can’t wait to hold my daughter, make her smile, see her grow and teach her all the good stuff this world has to offer. She has a lifetime ahead of her!
A little stressed, for all the same reasons. Man, that’s a huge responsibility!
So a few weeks back, I’ve wondered if there would be great a financial decision that I could already make for her? After some research, the most common advice was to open a 529 plan to financially prepare for her education.
An HSA for Education
Indeed 529 plans are great : it’s basically an HSA for college costs. You contribute after-tax dollars into an account, where investments grow tax-free. It’s even flexible enough to let you pick any 529 plan from any state, not only the one you reside in. There are also several rankings of the best plans available.
It’s also super flexible. The contribution limit per year is around 14,000$, per spouse. If the funds aren’t used with one child, the plan can be re-assigned. Almost anyone in the family can benefit: kids, parents, grand-parents, cousins, nephews and nieces … I suspect that there are smart ways to use this for inheritance purposes.
The only condition, is that if dollars aren’t used for eligible expenses, the returns (not the principal) are subject to income tax and a 10% penalty.
There’s plenty of reasons to like these plans.
A case against 529 plans
One of the first comments my wife received when she had her baby shower was “you’ll see kids are awesome”. Shortly after was “go open a 529 account for her”.
We have discussed and we built a case against it. This will arguably not apply to everyone, but this is our reasoning.
- International education: funds invested in the plan are meant to be used at US colleges. Our reasoning is that it’s very likely that a portion of our kids’ education will be abroad. If we move because of work (very likely), the company normally sponsors educational expenses. If we otherwise decide to relocate ourselves, we’ll pay out of pocket, but costs abroad can be significantly lower anyway. I can also imagine how in 15 years it will be even more important to have higher education in Asia. By then China’s GDP will have doubled and passed the US as the world’s largest economy, so careers may have different outlooks then. A 529 plan wouldn’t help in this case.
- Avoid being a maxed out 529 plan poor: similarly to being house poor, I don’t like the idea of locking money into accounts for special purposes. At least for the 401k, we get a company match, it’s tax deductible and growing older than 60 is an almost sure thing (knocking on wood). I use the funds in the HSA more quickly than they can grow (a pregnancy is not cheap) so I’m not too worried about locking too much money there. Locking away 250k$ or more in an account that I’m not sure I’ll use makes me feel uncomfortable.
- Keep capital available for other non-equity investments: in a 529 plan, i would typically be limited to investments in stocks and bonds. However, my goal is to buy another rental property starting next year. The return on rentals in Texas is quite good and returns of 15%-20% are not uncommon. That’d be a better use of capital. If my wife wants to start a business at some point, we could use seed capital. I don’t want to pass on these opportunities because my financial resources exist but aren’t accessible for this purpose.
- Fund kid’s costs with rental properties: This isn’t a formal plan yet, but the idea would be to invest in real-estate and use the cash flow to cover all of our kids’ costs. From day care to college and everything in between, this is an approach that I find more flexible and scalable. If I can have 1 or 2 rentals per kids generating 10k$ of cash flow a year, rents would basically cover their costs.
So my approach will be to fund our kids’ education (and the rest) with rental properties instead of 529 plans, so we can keep the flexibility to use our cash and reinvest it as we wish. It will for sure be more work than investing in index funds. But since this would also support our FIRE plans and help us cover even more of our expenses, it currently looks like our best bet for the next decade or two.
So I’m curious what your opinion is:
- Do you think the real-estate play is a good idea?
- If you invest in 529 plans, what is your experience with the investment vehicles at your disposal?
- Any advice for first time parents? 😉