While there certainly is no requirement to save money for your child's education, many military officers and senior NCO's want to do so. One vehicle for saving for college (and private education) is the 529 plan. But does it make sense?
The 529 Plan Explained
529 Plans are named after the section of the Tax Code that established them. At the Federal level, contributions to 529 plans are made with "after-tax" dollars. In other words you don't receive a tax deduction for the contributions. But, like a Roth IRA the distributions from a 529 plan are tax free if used for qualified education expenses (the list of qualified expenses is pretty broad and includes living expenses).
At the State level, many states give you a tax deduction for contributions to the State sponsored 529 plan. In other words, if you are a Virginia resident and you contribute to the Virginia 529 plan you'll get a tax deduction (in the case of Virginia, the deduction is limited to $4,000 per year, per donor, per beneficiary). If you contribute to USAA's 529 plan, Virginia won't let you deduct the contribution.
Active Duty Member Contributions to a 529 Plan
While on Active Duty, you'll receive the Federal Income Tax Benefits mentioned above. Since most Active Duty military members are residents of States that don't have an income tax, the state tax benefit isn't as compelling. You will give up some flexibility with a contribution to a 529 as it must be used for qualified education expenses or you will pay a 10% penalty on any earnings you withdraw and use on unqualified expenses.
There certainly isn't any problem with contributing to a 529 plan while you're on Active Duty, and the younger your children are, the more powerful the tax-free benefits become. If you're late in your career, then the case is less compelling and you certainly wouldn't be wrong by investing in a taxable account. If you do, make sure your investments produce tax advantaged income like qualified dividends and capital gains.
Retired Military Member and Contributions to a 529 Plan
When you add in the State income tax advantage, if your state offers them, then the case for a 529 plan becomes more compelling. In fact, many states allow you to take the deduction even if your funds are in the 529 plan for a short period. To my knowledge the longest the funds have to stay in the account is one year. So, if you know your child will go to college (or you want to pay for private school), then it almost certainly makes sense to take advantage of State income tax deductions. The higher your state income tax rate, the more compelling the argument to contribute.
But What About GI Bill, VA Benefits and Financial Aid?
The GI Bill and other potential VA Benefits (or state Veteran's Benefits) could make 529 contributions unnecessary. I still don't know if I would ignore 529 plans. The funds in a 529 plan may pay for things benefits won't pay for. Also, the student is not required to use the GI Bill stipend on housing. So 529 benefits could be used tax free for housing and the Gi Bill stipend could be pocketed...tax free.
If GI Bill or other benefits, including scholarships, cover all qualified education expenses, there is a "loop-hole" that forgives the penalty on earnings and you only pay the tax on the earnings. In effect, the account is taxed like a non-deductible IRA and you'll have the benefits of tax-deferred earnings. Or, you can name another beneficiary (generally a extended family member or closer) and continue to earn potentially tax-free income.
Funds in a 529 plan owned by a parent don't hurt your chances for needs-based financial aid any more than any other investment asset (with the exclusion of retirement accounts). So, if you would be saving the money anyway, then don't sweat this one. And if you're a retired Senior Officer or NCO and you're still working, your income will probably be too high for needs-based aid anyway. One word of caution though. If your alternate solution is to put money in an account in your child's name, the funds are counted much differently. 529 plan distributions by accounts owned by grand-parents are treated much differently too, so be careful there as well.
When It Comes To Finances Military Members Are Different
You just can't count on the generic advice you may find on the internet or get from well-meaning advisors. Financial advice for Active and Retired Military Officers and NCO's needs to account for your unique benefits, special tax situation and other options available to you. If you're looking for help, we concentrate on you each and every day.
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