Jordan Lee is the CEO and founder of CollegeBacker, a startup that helps people start 529 college savings plans. In this episode, learn what a 529 plan is, why it’s so important and how to get started.
In today’s episode, you’ll find out:
- What led Jordan to co-founding CollegeBacker
- How a 529 plan works
- The impact of saving when your child is young
- What counts as a qualified expense for a 529
- Tax benefits of a 529
- What’s a good annual contribution
- Should a 529 be priority over retirement savings?
- What superfunding is
- How to calculate what to save in a 529
- How friends and family can contribute to your child’s 529
- Which states provide income tax benefits with 529 plans
- What happens if your child decides not to attend college
- Differences between advisor-sold and direct-sold plans
- How to you might choose where to house a 529 plan
- How prepaid tuition plans work
- Can you save too much to a 529?
- Why every parent should contribute a 529 plan
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Episode 33 Transcript
Travis Hornsby [00:00:01]Welcome everyone to the Student Loan Planner Podcast. I’m very excited to have the CEO and co-founder of CollegeBacker on today — Jordan Lee. Jordan, welcome to the show.
Jordan Lee [00:00:09] Hey, Travis. How are you? Glad to be here.
Travis [00:00:10] We’re having the show today to talk about 529s, and that’s specifically what you guys do. And I think it’s a super important topic because a lot of the people that are burdened by student loan debt that listen to our show, they don’t want that next generation to end up in student loan debt.
What led Jordan to co-founding CollegeBacker
Travis [00:00:23] So, tell us a little bit about yourself and what led you to becoming the founder of this startup focused on 529s.
Jordan [00:00:30] Yeah. So, I grew up in Silicon Valley in Marin County near San Francisco. And I was kind of a child of the early internet — self-taught kind of Mac developer. When I got to college, I went on to pursue other interests. And, you know, I never expected to be a great student, to be honest. I wasn’t great in high school. It was an English teacher after my freshman year who challenged me to be a better student, and that kind of set me on a better path.
Jordan [00:00:57] But then beyond high school, I went to a bunch of schools. I started at Berkeley. Ended up transferring to Harvard, finishing there. And started studying other interests beyond tech — Chinese politics, actually, somewhat randomly, and political science.
Jordan [00:01:09] But I pursued that path for the next few years. Did a masters at Yale and was at a think tank in DC Brookings for a while. And got to Princeton to start a Ph.D. in poli sci (political science). And I realized pretty quickly that I wanted to get back to my roots in technology.
Jordan [00:01:25] But this whole journey that I’d kind of been on through academia was a huge door-opening process for me. I never expected to have a lot of the opportunities that it led to. And so when I found myself in technology a few years out of my program, I wanted to find a way to give back if I could.
Jordan [00:01:43] I had happened upon this insight around college savings largely because a bunch of my friends who had gone to various schools as well came out with tons of student loan debt and really didn’t want their kids to have the same kind of fate that they had. And, you know, a lot of them were starting to have kids right around then. And one of them mentioned a 529 college savings plan to me and described it so clearly to me as, like, a Roth IRA but for college. So kind of like a retirement account but for college costs.
Jordan [00:02:13] And I’m something of a personal finance geek. I just hadn’t had occasion to think about 529s at that point. But I got it immediately, and I asked him how much he was putting in. And he sort of stared blankly at me for a second. And [he] was like, “Oh, you know, I haven’t actually set it up. It’s a little complicated. I did a lot of research a few weekends ago, and I kind of got stuck. There’s like this state-by-state thing and all these rules. And I’m going to finish it this weekend.”.
Jordan [00:02:38] So, you know, that’s kind of like the little entrepreneurial light bulb went off for me. If this person, who has a good educational background, has resources to be investing and, most importantly, the intent — actually knows what this thing is and wants to do it — is not doing it, just imagine all of the millions of parents out there who just get stuck on step one basically.
How a 529 plan works
Travis [00:02:59] Tell us a little bit more about a 529 because I think a 529 for the average person is just a bunch of numbers, and it doesn’t make a whole lot of sense really at all as to what it is. So, you said a 529 is a Roth IRA for college. What exactly does that mean?
Jordan [00:03:15] Yeah. So what that means is you put money in post-tax, and then it grows tax-free. It’s invested, and it grows tax-free. And then when you take it out, ultimately, you get tax-free distributions. And so there’s zero capital gains tax on all of the growth and then all of the ultimate distributions out of the investment account, for when you actually use it to pay for what are called qualified education expenses.
Jordan [00:03:41] But that’s actually very broad. Pretty much everything that goes into paying for college, and, at this point, also a certain amount can be used for K-12 private school tuition — are all qualified education costs.
Travis [00:03:53] OK. So basically, tuition and fees are qualified expenses at any undergrad for sure. Is there anything else? Like, what about room and board? Like, is that not a qualifying expense?
Jordan [00:04:03] That is, actually. Yeah. And also certain supplies that you need, such as a computer, for instance. Books, textbooks and so on. All of the — All of that counts as qualified expenses. So it’s pretty broad, actually. And you can use it for undergrad, or you can actually use it for graduate school if you want as well.
Jordan [00:04:22] And then, you know, as I mentioned, a recent development with the tax reform is that you can use it for K-12 private school tuition, up to $10k per year in addition to higher education.
Travis [00:04:34] OK, so grad school — I could use it for an unlimited amount for grad school? Is there a cap on how much I can use for grad school purposes?
Jordan [00:04:40] Unlimited.
Travis [00:04:40] Unlimited.
Jordan [00:04:42] So there’s no cap. There is a limit on how much you can put into a 529, but it basically tracks, like, the expected overall cost of a four-year degree. So, for most 529s, it’s around $400k or $500k, given that sadly, some schools may cost roughly that amount in 10, 15, 20 years.
Travis [00:05:02] OK, so just so our audience is, like, crystal clear on this 529 thing, right? I have a baby, and we want them to go to a really fancy school. We just want them to be super educated, and we want them to go to some school with no debt because of how big of a burden it was for us. Right? If we put this money in now, we’re not going to get a tax break now, except for state income taxes in some states.
Jordan [00:05:27] So, it’s post-tax dollars, if that’s what you mean. Yeah. So, it’s not like a 401(k), for instance, where you’re putting pretax dollars in. However, you do put those post-tax dollars in; they do get to grow completely tax-free until your kid is ready for school or whenever you take a distribution. And then that distribution is also free of any capital gains tax you would normally have paid on that growth, on that appreciation of your investment.
Travis [00:05:53] Right. That’s so important because I just wanted our audience to understand. So this is not something that’s going to reduce your adjusted gross income (AGI) now, which a lot of the people really want because they’re paying, you know, student loan forgiveness type programs, where they’re trying to get their taxable income really, really low. So, this is not something that’s going to help them now in terms of their AGI. But it’s something that’s going to help your child later in a big way.
The impact of saving when your child is young
Travis [00:06:13] The one thing that I think is really interesting is I had a 529 that my grandparents started for me back in 2007 kind of time frame. But they started it basically a year before I went to college. And so because of that, there was — there was really no big gain. And it wasn’t a huge amount anyway, but there was no big huge gain in it. So I wasn’t really able to benefit from years and years of tax-deferred growth. Right? Tax-free growth.
Travis [00:06:38] And so that’s kind of interesting because a lot of people, they think about 529s when their kid is going into high school. Right? So what kind of impact does it have when I start thinking about saving for my kid’s college — but, you know, when they’re, like, one or two years old. Like, how big of a difference does that make in terms of how much I need to save to cover their education?
Jordan [00:06:56] Massive. We recommend — We’re an investment adviser registered with the SEC (U.S. Securities and Exchange Commission), and we’re big fans of passive investing — very low-fee, index fund-based approach to such a long holding period type of investment. And that only works if you do have a long holding period.
Jordan [00:07:13] So you’re basically starting early. And if you put a regular amount in, even if it’s a small amount, over a long enough period of time, you can really make significant progress because of the compounding of the returns.
Jordan [00:07:27] And so it’s certainly worth considering a 529 still all the way up into high school because, you know, you end up paying for university for another four years after your kid starts. But if you can get started early, it really pays off.
Jordan [00:07:42] And so, you know, we’ve actually — We launched a feature with CollegeBacker. So, CollegeBacker makes this whole 529 thing so simple that it takes five minutes, [and] you’re up and running with the right 529 plan with the right portfolio.
Jordan [00:07:55] It’s an age-based one, so, you know, if you do start really early, the portfolio is going to start out more aggressive with more equities. And then over time, it kind of moderates and becomes more conservative. So, by the time your kid does get to high school, it looks more like a fixed-income type of securities investment that is much lower risk.
Jordan [00:08:16] But what we’ve seen is actually since we launched this feature in the fall called Future Baby Funds, where you can literally set up a college fund for an unborn child, 20% of our sign-ups have actually been these types of funds, which just speaks to the sort of yearning that this generation has to avoid the student loan crisis for their kids. To help them avoid that fate that they faced.
Jordan [00:08:37] As your audience knows, that $1.6 trillion crisis that is at the federal level and is the subject of our Democratic primary campaigns right now. And I think this generation, just more than any other, understands how important it is to get ahead of it. And so we see it in our stats, including with this Future Baby Fund.
What counts as a qualified expense for a 529
Travis [00:08:57] In terms of, like, using it for college, you said I can use it for any qualified expense. But qualified expense — Let’s get into the nuts and bolts of this. So I get a tuition bill, and I could use the 529 tax-free. And then I get my different random itemized bills; I could use it for that. But what about — Like, the room and board thing, I wanted to ask you a little bit more about. Like, the room and board thing, is it just, like, a bill from the school for housing? I can cover it with my 529 if I live off campus — can I pay it with that? What are the restrictions on that?
Jordan [00:09:25] You can use it for off-campus housing as well. It’s pretty simple how you actually end up demonstrating or not demonstrating that you’ve used the 529 for the right purpose. The burden is basically on you, if you say you have done a non-qualified withdrawal, to report it to the IRS.
Jordan [00:09:46] And so the assumption is that if you have taken a qualified withdrawal, you’ve indicated that you plan to use the withdrawal proceeds for qualified expenses, then you don’t need to prove any of that. You don’t need to demonstrate it. It’s more if you decide to do an unqualified withdrawal, you do need to declare that.
Jordan [00:10:05] So you would just pay for those normal expenses. You will have taken a withdrawal from the plan, just transferred it to your own bank account. Or if you wanted, you could have a check written to your child directly, or it could be sent directly to the school. So those are the three sort of distribution methods that you can do.
Jordan [00:10:24] But we see many people just kind of withdraw it themselves, and then, you know, they’re paying for the costs from their account.
Travis [00:10:33] OK, cool.
Jordan [00:10:35] Does that makes sense?
Travis [00:10:35] Yeah, I think it does. Like, it seems like it’s not super easy to screw up, is what I was trying to get at.
Jordan [00:10:40] Exactly. Yeah. There’s not a whole lot of work on your part. As long as you’re in the spirit of it, trying to pay for the right costs with it, then it’s on your side to make it easy to do that.
Tax benefits of a 529
Travis [00:10:50] Sure. Now, can you tell me a little bit more about just, like, the tax benefits of a 529? Because they do exist, and they’re kind of significant in certain states that have high income taxes. So, can you share a little bit about, for example, what states I could maybe use to use CollegeBacker and get a state income tax deduction?
Travis [00:11:09] And then I think that there are some states where you have to use the state-specific fund to get one. So, can you kind of explain that for our listeners? Because we have got a lot of people in a very high-income tax states that are interested in that.
Jordan [00:11:23] Yeah, absolutely. This is an interesting aspect of the 529s. Because they’re offered by individual states, the states often do add an incentive to use their state plan. But the first thing to say is, you know, at the federal level, all 529s kind of work the same way. It’s tax-free growth. Tax-free distributions. So that’s where the biggest gain is basically made.
Jordan [00:11:45] But then if you are considering sort of the state-by-state factor, one should look at some resources online. We can — We have an FAQ page that kind of details which states work in which way. But some states are generous and have a larger-than-average state tax credit or deduction that is worth investigating.
Jordan [00:12:05] It’s more important if you are going to be putting the lion’s share of the money into the plan because then you’re able to claim that tax advantage at the state level for your state income taxes.
Jordan [00:12:18] If you are looking to involve other people, to have them gifting into your plan, then it’s not quite as important that you sort of optimize on the state tax level because those third-party contributions are not going to be subject to the same kind of tax incentives at the state level.
Jordan [00:12:35] And what we’ve actually seen with CollegeBacker is because we have this ability to invite friends and relatives to chip into your college fund — And they can actually do it on an ongoing basis if they want. So, at a birthday party, someone could contribute a one-time gift. Or you could have the aunt kind of contributing every month $10. We actually see a lot of grandparents kind of chipping in an even larger amount on a regular basis.
Jordan [00:12:58] But it all adds up to about an average of 43% more saved by CollegeBacker families when they do this — What we call circle funding. It’s kind of like crowdfunding, where you’ve got, in crowdfunding’s case, a lot of strangers potentially contributing to your campaign. Circle funding is more about your close circle of friends and relatives, all the people who actually know you, actually care about your kid and would like to give, you know, maybe a more meaningful gift than another onesie or toy that ends up in the closet and so on.
Jordan [00:13:28] And so if you do the math on the marginal tax savings that you get by choosing your state plan as compared to just using a tool that helps you raise more money from third parties, a lot of families, you know, if they’re just putting in $100 a month, for instance, they may get an extra $60 off their state tax return because of that decision to go with their state plan. But our average family raises 43% more from their friends and relatives by circle funding.
Jordan [00:13:59] So, I think, like, one aspect about the 529 landscape that is sometimes exaggerated a little bit too much is how important it is to go with the right state plan as opposed to just using the vehicle in the most powerful way possible. Because if you use it more and if you get more people involved, then you’re going to have much more actual principle to contribute into your investment.
Jordan [00:14:22] And that ultimately is going to dwarf the marginal tax savings you’re going to get by making the kind of tax-optimal choice in many cases — not all cases. And so it’s definitely important to do some research online. Consider your state plan. Play with some of the calculators to figure out what exactly your state tax incentive is going to look like.
Jordan [00:14:42] But ultimately, I think getting a good plan, like a high-reputation, stable one, and then making the most of it is more important than optimizing for the optimal tax structure with the plan.
What’s a good annual contribution?
Travis [00:14:53] That’s a lot of information, so that’s maybe, hopefully not too overwhelming to some of the people listening. So let’s talk about contribution limits. I could put $6k a year into my Roth IRA. But first of all, like, I don’t even know what I should be putting into my kid’s college 529. Do you have a recommendation for what’s a good annual amount, if you’re starting with the kids young?
Jordan [00:15:13] Yeah, it definitely depends on what kind of school you’re targeting. You know, if you know that you’re — that you want your kid to go to a private school or an out-of-state public school, then you should save about twice as much as if you’re targeting an in-state public school. But generally, you know, if you get going early enough, you can afford a large chunk of college if you’re doing $100 a month — that’s sort of like a very vague rule of thumb.
Jordan [00:15:39] If you visit CollegeBacker.com, there’s a calculator where you can kind of see the likely returns that you’re going to get by using CollegeBacker as compared to other kind of investment vehicles. And there are a bunch of other sort of interesting calculators available online that I’m happy to provide some links that you can put in the show notes.
Jordan [00:15:57] But it really just depends on how early you start because, you know, if you’re getting started when your kid is just born, you can certainly afford to put in less each month and get to the same outcome.
Travis [00:16:08] The less is what [exactly]? So like, $100 hundred a month is what you’re saying is a good starting point for people?
Jordan [00:16:13] Well, it’s a very vague rule of thumb because it really depends on individual families’ goals. But what we recommend, if you’re trying to comfortably pay for college, then we recommend you target one-third of the expected cost of college. And the rule of thumb there is, you know, you could rely on scholarships and financial aid for one of the other thirds. And then the last third, you could pay with current income, or, you know, maybe your kid has work-study and can contribute a bit themselves.
Jordan [00:16:41] And so, just projecting out 15, 20 years, a private school may cost around $400,000 to $500,000. And so, if you’re getting started today, then I think you’ll be in a pretty good place with about $100 a month. But it really depends on exactly how old your kid is and how long you expect to grow that investment. And so families are best off visiting one of these sites like ours to play with the calculator to figure out the appropriate amount.
Jordan [00:17:07] You know, a lot of families in this generation are just trying to get out from under their own student loans, and so they don’t have a ton of disposable income to invest in something like this. And one of the pitfalls there is thinking, “OK, I don’t have a ton of extra money. I shouldn’t get started on this until I do all these other things maybe.”.
Jordan [00:17:27] Certainly you should have an emergency fund first. But beyond that, like, do you need to focus solely on your retirement before you think about college savings? Do you need to pay off all of your debt before you start to think about college savings?
Jordan [00:17:41] We found that a lot of millennial families especially are thinking ahead and starting with the savings process, even if it’s a small amount initially, just to get some traction, some momentum, some behavioral regularity in the savings process. And then over time, as, you know, your financial circumstances change and you have more disposable income, you can increase that monthly amount.
Jordan [00:18:02] But you’ll be very glad, you know, five years later after doing $10, $15 dollars a month to see that it’s already grown to potentially a few thousand, which is a decent chunk of change when it comes time to actually pay for college.
Should a 529 be priority over retirement savings?
Travis [00:18:16] Yeah, like — So, $100 a month, if you start when your kid is a baby, then you could have tens of thousands of dollars actually, I mean, to send them to college. And this is not a small amount of money.
Jordan [00:18:24] Oh, yeah.
Travis [00:18:24] I will say this, though. I mean, I do think that 529s fall after a couple other priorities that are more important. They always say you can borrow for college, but you can’t borrow for your retirement. So, if we have parents out there listening, I would personally put retirement accounts as a priority. That’s more important than 529s.
Travis [00:18:41] But what we’re trying to get people to do with Student Loan Planner is to save a lot of money. I want everybody that talks to us to save a lot, even if they’re going for loan forgiveness or refinancing whatever it is. And so, after you’ve maxed out your retirement accounts and after you’ve started your brokerage account, this 529 is basically the generational wealth thing. And generational wealth — I don’t mean giving people trust funds. I mean giving people the best gift you can give somebody, which is, you know, a zero-debt college education. Right?
What superfunding is
Travis [00:19:07] So let’s say I’ve got a rich uncle, right? We’ll call him Rich Uncle Bob. And Rich Uncle Bob wants to put in $50,000 into my kid’s 529. That’s over the gift tax limit of $15,000 a year tax-free. Right? So how does — Can Uncle Bob do that? Is that legal?
Jordan [00:19:24] Rich Uncle Bob can do that. What it’s called is superfunding the account. And so with 529s, there’s a rule that allows you to put up to five years of the $15k all at once into a lump sum contribution. So you can actually do $75k — anyone can — to the kid’s fund.
Jordan [00:19:41] Families that do have more resources, sometimes they will kick off the 529 with both parents, for instance, each contributing $75k for $150k. That’s, like, the best-case scenario, if you happen to be in that kind of situation.
Jordan [00:19:57] But for grandparents, they also can do the superfunding, if they’d like. And then, you know, if they are going to be giving any other gifts to the child over the next five years, they just have to report that to the IRS.
Jordan [00:20:08] It goes against the lifetime gift tax allowance limit, but you can certainly lump in that large contribution up front if you’d like to. And then of course, you have more time for it to grow.
Travis [00:20:19] Yeah. So, grandparents and parents can do the superfunding. Can anybody do the superfunding?
Jordan [00:20:24] Yeah. Anyone can actually do it because it’s the gift tax rules applied between two individuals, and 529s let you do five years at once up front. And anyone can give to a 529, if they’d like to.
How to calculate what to save in a 529
Travis [00:20:37] Yeah. So, let’s just get into the numbers and just create some weird rules of thumb because this is fun. You’re saying target about a third of the cost of the place that, you know, you think you want to go. So are you — You mean a third of the cost of what you think it’ll be in 20 years? Or a third of the cost, like, in today’s dollars?
Jordan [00:20:53] Where you think it’ll be. You have to do the calculation on college cost inflation. And unfortunately, college costs have been rising a lot faster than inflation. And I think it’s up 12X over the last 30 years or something like that. Expected to double again over the next 10, which is how we kind of arrive at that roughly half-a-million-dollar price tag for a private school education.
Travis [00:21:18] So let’s say my wife went to Penn State, and so she wants our kids to go to Penn State. I want them to be a Florida Gator. That’s where I went. But you know, let’s say that she thinks they’ve got to be Nittany Lions. So, it’s like $25k a year there, plus, say, $20k of miscellaneous expenses. Right?
Travis [00:21:33] So let’s just say, like, $40,000 times four is $160,000. Let’s say that it’s going to double in 20 years, just because, you know, there’s all kinds of more-attractive alternatives to college. Maybe they stop being able to raise it up faster than inflation every year because people are saying, “Look, man, this is, like, a racket. It’s not worth it.” I don’t know.
Jordan [00:21:49] Hopefully there will be a correction of some sort.
Travis [00:21:52] Yeah. Well, there should be, right? Like, a lot of people write these articles, like, ‘college is a scam.’ I wouldn’t go that far. But I would say that it’s definitely overpriced for the value that it’s delivering. So, let’s say that the inflation rate slows down, so $300k is the thing I’m trying to save for the future. And so you’re saying I should target maybe $100k of that because maybe they’ll be a star mathlete or athlete or something like that, and they’ll get a scholarship of some kind or maybe financial aid or whatever. Right? So $100k is what we’re aiming for.
Travis [00:22:20] And so then, if I think about what I need to save in terms of like a lump sum, if you think about [the fact that] your money can double every 10 years at a 7% investment return, that means to have $100k when my kids go to college, like, I kind of only need to have, like, maybe $20,000 or $25,000 now to potentially have that $100k in the future for my kid. Right? So, that’s pretty cool.
How friends and family can contribute to your child’s 529
Travis [00:22:42] But your special feature about your business is this social contribution thing, and you talk on the show about how that increases people’s contributions, right? So, I like that idea, as it relates to your company specifically, but I really want to talk about it more in general. Like about increasing your savings rate. That’s really critical. Most people don’t have the $20 grand lying around that they can just dump into a 529 that’s going to quadruple in tax-free value that you can use towards college one day.
Travis [00:23:07] So, like, this automatic contribution thing —If I want to send my kid to, like, a really prestigious school, what kind of impact would having $300 or $400 a month have? And then, you know, if I can add on a couple of my family members or friends, you know, what are we talking here? What’s the potential opportunity?
Jordan [00:23:23] Yeah. Well, you know, let’s just imagine if you’re starting when your kid is born, so you have 18 years — 18, 19 years — to grow the investment. If you were putting about $100 in each month, then that’s projected to grow to around $45k with CollegeBacker by then.
Jordan [00:23:43] But then the real power is if you, let’s say, get one friend or relative putting in $25 a month, then suddenly, you know, you’re up to $57,000 because you’re effectively going from $100 per month to $125. So it’s 25% more. But let’s say you get two to do that. Then you jump it up another 25% from the base. So, it’s very powerful, even if you just have a few friends giving in a regular amount to save a lot more.
Jordan [00:24:13] Of course, if you can get larger upfront gifts from certain relatives like grandparents, you can kind of get closer to that that scenario where you do have the $20k to drop into the account early on. Of course, not every family is able to do that.
Jordan [00:24:26] But if you can, you know, for instance, have a birthday party for the kid’s first birthday where you’re using CollegeBacker to accept gifts instead of toys and so on. We’ve seen, you know, families raise a couple thousand dollars up front right at the outset there that is expected, as you say, to double a couple of times by the time the kid is ready for college.
Jordan [00:24:47] And the cool thing about CollegeBacker is, you know, once someone gives a gift, they always have the option of giving a subsequent gift. And, you know, we see sometimes it becomes a regular annual gift. You can actually turn it into that with CollegeBacker, if you want. You can basically set up an annual gift of, say, $100 to a child you care about if you don’t feel quite ready to go to the monthly thing, which is certainly a larger commitment.
Travis [00:25:12] And that’s interesting. So, you can do the lump sum contributions if you don’t want to have some sort of automatic recurring contribution is what you’re saying.
Jordan [00:25:17] Oh yeah, totally. And, you know, given that a lot of the families that are using CollegeBacker didn’t know about a 529 before, just because, you know, like most Americans, actually 70% of them haven’t heard of a 529. Many of our families come and learn about them from CollegeBacker for the first time.
Jordan [00:25:35] And so quite a few of those families actually already have savings. It’s just — It’s sitting in a checking or savings account, sort of loosely earmarked for college and maybe getting, you know, a tiny little bit of interest that’s not keeping up with inflation.
Jordan [00:25:49] But once they realize they can put it into this this tax-free vehicle, they’ll do an initial transfer of maybe $5,000, sometimes $10,000 and so on to help kick it off in a pretty aggressive, exciting way.
Which states provide income tax benefits with 529 plans
Travis [00:26:00] Yeah. So, I wanted to read this from your site just because I think this is really useful information. These states provide no benefit for your income taxes, if you have a 529. All the tax-free states. So, if you don’t have a state income tax, you’re not going to get a tax deduction on your state income taxes for contributing. That’s kind of obvious, right?
Travis [00:26:17] And then the federal stuff — it’s the Roth IRA for college. So there’s no upfront taxes at the federal level, but there are some deductions for state. So, some of those states, besides the ones that don’t charge an income tax, California, Delaware, Hawaii, Kentucky, New Jersey, North Carolina, Tennessee, Wash — or, Washington doesn’t have an income tax and Wyoming I don’t think does. But those states don’t give any special tax benefits.
Travis [00:26:39] So I live in Missouri, and Missouri gives a tax deduction for any contribution to any state’s 529 plans. So does Arizona, Kansas, Minnesota, Montana, Pennsylvania and Utah. So that means you get a deduction on your state income taxes for contributing, which everybody knows how much I love tax deductions. So that’s really cool, like, to just make a contribution and get a 6% deduction on your state income tax returns. So you put in $1,000 and save $60 bucks in taxes on your state income tax because you made this contribution for your kid’s future.
Travis [00:27:11] And there’s certain states that you have to open a 529 actually in the state itself to get the tax break. And there’s a fairly long list of those: Alabama, Arkansas, Colorado, Connecticut, Georgia, Idaho, Illinois, Iowa, Louisiana, Maine — I’m just reading all these off — Maryland, Massachusetts, Michigan, Mississippi, Nebraska, New Hampshire, New Mexico, New York, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Vermont, Virginia, West Virginia and Wisconsin.
Travis [00:27:34] So I probably shouldn’t have read all those, but I just thought I’d read that just in case you’re listening to this and you’re like, “Oh, that was my state. I heard my state.” So if you heard your state in the “you have to open an account with that state plan to get benefits,” then you might want to consider opening an account with a state plan.
Travis [00:27:51] Like, New York, has a state 529. I can’t speak to the investments in the New York 529, but if I lived in New York, I’d probably look there first.
Travis [00:27:59] One thing that’s kind of cool is you can have contributions made with this CollegeBacker thing. You know, this social contributions to the account with people living in different states. Right? So you can have this account. You can have a 529 because your state has these great tax rules, and you can have one that’s set up just with you guys to collect, like, friends and family contributions. Is that correct?
Jordan [00:28:22] Yeah. Yeah, exactly. And so we’re not able to offer every state today. So we only offer, you know, certain states, but you can have multiple 529 accounts for the same beneficiary.
Jordan [00:28:34] So, you know, if you are in one of those states where there’s a really-generous state tax incentive, then it could make sense to sort of max out your incentive first with a state plan. And then, you know, you could have a separate fund with CollegeBacker that’s purely for gifting.
Jordan [00:28:49] And then, if you ever needed to roll one into the other or transfer the funds, you know, we’re happy to help with that as well.
What happens if your child decides not to attend college
Travis [00:28:54] OK, so, let’s say that I save all this money in this 529, and Junior decides that he wants to join the circus. And so I’ve got $100,000 that’s reserved for college that I have to pay ordinary income tax rates on and a 10% penalty tax if I don’t use it for college. So, holy cow, I’m going to pay 50% in taxes to get my money out.
Travis [00:29:19] But I have a daughter Susie that wants to be an astronaut, and, you know, she wants to go to M.I.T. But the name on the 529 account was for Junior. What do I do? Do I have to pull the money out and pay 50% in taxes? Or can I do something sneaky?
Jordan [00:29:34] Thankfully, you don’t have to do anything sneaky, and you can transfer the 529 to a different beneficiary within the family. So, they did plan for this scenario. The definition of actually in the family is pretty broad, too. It covers pretty much everyone you can think of, except second cousins and beyond. So. But it can be step, you know, a stepbrother, step-nephew, etc.
Jordan [00:29:58] And so you’re able to do that with no hit on the actual account, so you don’t have to pay tax or a penalty if you do that.
Jordan [00:30:05] Actually, one thing to note, though, is even if you did have to withdraw the money for some other purpose that’s not qualified, the tax actually is only on the earnings portion of the investment, and the penalty is also only on the earnings portion of the investment.
Jordan [00:30:20] And so, this is kind of a common misconception out there, which just makes 529 plans even more confusing than they need to be. But you’re still better off having invested the money in most cases, assuming that it grew, than having just put it into a savings account. Even if you pay that 10% hit and the tax on the earnings portion because it’s not a qualified withdrawal.
Travis [00:30:41] OK. So that’s good. I could even open up a 529 in my name now before we even have an unborn child and then switch it to the child’s name later. Right?
Jordan [00:30:49] Exactly, yeah. And that’s actually how we’ve made our Future Baby Funds work. So, you know, it’s usually kind of a pretty clunky, paperwork-intensive process to do that, and you really have to be an expert kind of trolling the college savings blogs to figure out how to do it. We’ve made it a one-button kind of experience. You can set up the fund for your future child, and then, when the child arrives, we help you transfer the beneficiary really easily.
Travis [00:31:15] That could really pose some unique opportunities for posting on social media. Right? Like, along with the baby-bump announcement, you know, and the ultrasound picture that you post on Facebook, you know, you put a little link in there, too, to your account to contribute to the Future Baby Fund for college savings. I mean —
Jordan [00:31:30] Totally.
Differences between adviser-sold and direct-sold plans
Travis [00:31:31] That would be pretty hilarious. See, I love this because I think that more of these cool things should happen in life. And because of these new startups like yours and others where it’s just a lot easier than it used to be in the past, people can contribute monthly amounts, and I just think that’s great. Now, you use Utah’s state fund that uses Vanguard funds? Or who do you use?
Jordan [00:31:50] Yeah, that’s the one we recommend now. And, you know, we may add a few others later, but our priority is to vet the landscape. Make sure that we are offering one of the best plans there is. And so, currently happy to be able to offer Utah, which is certainly one of them. Very low fee. Stable administration. Lots of assets under management.
Jordan [00:32:10] But in the future, we may offer a couple other states. Never going to go for a comprehensive, like, offer every state because to be honest, some state plans just haven’t had the best track record. And we take our duty as an investment adviser pretty seriously, and, you know, we’re a fiduciary to our clients. And so we only want to recommend the best.
Travis [00:32:28] What’s an example of a state that’s done terrible?
Jordan [00:32:31] Oh, I mean, I don’t like to call people out.
Travis [00:32:34] Tell me everything but the name.
Jordan [00:32:35] Well, if you google, kind of, Morningstar worst-performing 529 plans, you’ll get some quick names popping up.
Travis [00:32:43] OK. Like, 2% fees a year? Something like that? Like, super-high mutual fund fees?
Jordan [00:32:47] Yeah, definitely the fees are an issue in the industry. And, you know, there are a lot of adviser-sold plans.
Travis [00:32:53] Oh, yeah.
Jordan [00:32:54] You know, we’ve been talking mostly about the direct-sold landscape that at least is typically much lower fee on average and do recommend these lower-cost investment options.
Jordan [00:33:05] But then on the adviser-sold plan side, you do have brokerage houses that want to make a profit on these things. And they’re much smaller average account sizes than the other products that they’re recommending. You know, retirement, taxable investments and so on. And to sort of get anything out of them, they end up putting on huge fees. And this, of course, eats into your returns and ultimately it makes you save a lot less.
Jordan [00:33:28] So, there’s already been a national sort of movement away over the last five or 10 years from adviser-sold plans to direct-sold. It’s about half-and-half of the assets in the industry today. But I think that trend is, just like we’ve seen Vanguard take on so much assets over time, I think the natural — the same trend is going to happen within the 529 industry.
Travis [00:33:49] Yeah. So, adviser-sold plans. Does this does mean they’re charging me a 5% commission to get my money in the plan every time I contribute? Or what exactly?
Jordan [00:33:57] It depends because there are lots of confusing rules around different share classes. But there are certainly some that have an upfront commission. But pretty much across the board, they have a much higher average annual fee. I think the average is around 130 basis points, where, if you look at the direct-sold kind of landscape, it’s more of that 60 — 60 basis points. And the one that we recommend is more like 18, 15 to 20, as the age-based portfolio changes composition. So very, very low fee.
How you might choose where to house a 529 plan
Travis [00:34:30] So here’s a question. I like your business model a lot more than I like the adviser-sold plans. But the natural question is, I can open a Utah 529 directly with Vanguard, if you already have a Vanguard account. And obviously you guys have to make some sort of return at some point. So, why would I use you guys versus Vanguard in terms of, like, what the fee is with you guys now and what could it be in the future?
Jordan [00:34:53] I mean, we’re free to use. We’re a free service because we really believe in reaching as many families as possible. We kind of believe that the structure of the industry so far has made it so that not enough families are included in 529 savings. And part of the reason is because it’s especially on the adviser-sold side. They’ve been driven by assets, and so they want families with more assets. Whereas we think every family should have a college fund, even if they’re just putting a few dollars in it each month. Because over time, that builds and they can get other contributors.
Jordan [00:35:25] And so, to support this sort of mission that we have of a college fund for every child, we made the bold decision not to charge an assets-under-management-based fee because that would incentivize us to go after richer families and then also to rely on the generosity of our users to actually pay us.
Jordan [00:35:42] And so, we have a tipping model. So whenever you contribute into the fund or whenever a third party — a friend or a relative — chips into your fund, there’s an option to tip us, if you want. And what we’ve found is, you know, families are quite generous, actually, when you have a company like CollegeBacker that’s extremely transparent about how it makes money.
Jordan [00:36:03] And there are no hidden, sneaky fees or anything like that that they’re used to. And when, you know, they’re giving money to a kid’s future, you’re already in kind of a frame of mind where you’re feeling good about this action that you’re taking. And, you know, this company that shares your values is making it possible.
Jordan [00:36:19] And so people are actually quite generous, certainly generous enough for us to be able to continue to grow and be on a path to profitability. We’re still a young company, so we’re not there yet. But it will certainly be a sustainable model for us.
Travis [00:36:34] Yeah. And full transparency in the way I think about these kind of things — and this is not just for you guys, but this is for any high tech, you know, Silicon Valley, like, a lot of investors working in a company kind of thing. If, for whatever reason, heaven forbid, y’all’s startup ceased to exist, right? And I had a big account with you guys. I don’t technically have the money invested in CollegeBacker stuff. I have it invested in the Utah 529 plan, right?
Jordan [00:36:59] Correct. Yeah. Your savings are safe, no matter what happens to us. You’ll always have that account with Utah, in this case — and, you know, maybe it’s a different plan in the future. And then they’re of course working with entities like Vanguard or Dimensional, which are extremely well-known. Aren’t going anywhere.
Jordan [00:37:15] So yeah, you’re in good hands. Even if we were to sell to a different company or go out of business, whatever kind of scenario you can imagine, it wouldn’t negatively impact our families.
Travis [00:37:26] Right. So, like, the way I look at companies like Vanguard, like, a lot of times I get questions like, “Why should I use Betterment versus Vanguard?” And the way I kind of look at it is, you get a way better website. It’s going to be a lot easier to save more money when you have a better site and a better customer service experience.
Travis [00:37:41] I have friends actually that work in Vanguard’s 529 department — or, at least, have worked there — and it’s a good department. Like, there’s definitely, you know, they definitely helped a lot of people save for college.
Travis [00:37:50] But I don’t think that there’s that potential with, if you have your Vanguard 529, for that viral social media moment where you’re getting a lot of friends and families chipping in to college, like there is with your situation.
Jordan [00:38:01] Yeah. We kind of focus on something that we’re good at, which is providing the user with a good experience. And typically, that’s not something that the finance industry has focused a lot of attention or energy on.
Jordan [00:38:14] So, you know, we meet the millennial family where they are. We design things to work on your phone. We have a mobile app coming next month. We support multiple payment methods, like credit and debit for third-party contributors, which none of the plans offer. We support this idea of contributing in a recurring basis, not just a one-off thing where you have to type in your account number, routing number.
Jordan [00:38:37] So, we just listen to our user base, and we try to build what they want. And the whole mission here is help you make the most of this thing. Like, it’s great to have it, but if you’re not actually using it and you’re not using it in the optimal way, then you’re kind of losing out on a lot of potential savings there. So, if you’re going to do it, you should do it right, is kind of our perspective.
Travis [00:38:59] Yeah. So, like, let me be clear. Like, I don’t really care so much where you do the 529 — obviously, I don’t want to offend you, Jordan. But, you know, I just want you to do it. And I think that if you —
Jordan [00:39:11] Same with us.
Travis [00:39:12] Yeah, exactly. So, if you have an account with Vanguard that you’re really happy with, then open a 529 with Vanguard so everything’s at the same place. You know, all your IRAs, your taxable accounts, your 529 — they’re all there.
Travis [00:39:24] If you have a Betterment account or Wealthfront account where you like having robo advisors kind of manage stuff for you and you like the sleek online interface and you find it really easy to be motivated to save more money, then I think that I would probably use you guys for a 529, if you’re more in that line of having that better experience. Because I do think that the impact of having a little bit lower savings rate because you had a little clunkier website to deal with is potentially thousands of dollars less in your kid’s 529 account.
Travis [00:39:52] So I think that there’s a clearer case to be made for using you guys in the sense of, I wouldn’t consider it a big risk because again the money is with this very safe institution. You guys are really just the portal that people are going through to aggregate all of these different contributions from different people that care about this child so that child can have less debt, which I think is a wonderful thing.
How prepaid tuition plans work
Travis [00:40:12] So, question about prepaid tuition plans. Obviously, these are a lot of times, I think, in lieu of 529 plans. My parents used one for me in Florida, and it worked out fantastically well. But then they made it a lot worse where you had to pay it like an extra premium. They basically — They realized they were offering way too good of a deal back when I was born, so you can prepay tuition at today’s levels. So when I was born, I think it was, like, $2,000 or $3,000 bucks. And so $2,000 or $3,000 — that was for four years of tuition anywhere in the state of Florida.
Travis [00:40:45] And so I was super, super lucky that my parents did that because then when I went to college, the four-year cost was obviously drastically more than that. And then they realized, like, for future kids, they’re going to tack on this premium surcharge if you’re going to go to, like, a flagship state university or something.
Travis [00:41:01] What do you think about prepaid tuition plans? Obviously, it’s like a broad question. There’s probably some good ones and some bad ones. But what do you think about that?
Jordan [00:41:08] Yeah. I mean, the results you had sound great. So they certainly work for some families. You just have to be pretty comfortable making a decision up front about where the kid is going to go to college, you know, limiting the options set.
Jordan [00:41:21] And so, I think because of that, you know, they’ve kind of gone a little bit out of style over the last 10 or 15 years, where the college savings version of the 529 has really taken off and kept growing and has more and more assets every year.
Jordan [00:41:36] Prepaid, it’s kind of languished a little bit. There are certainly some good ones still out there, and if you know that you want to send your kid to a certain university system, then I think it still can make sense and it’s worth looking into.
Jordan [00:41:48] But if you do want to prioritize the flexibility, then you’re probably better off going with the 529 college savings plan.
Can you save too much to a 529?
Travis [00:41:55] Yeah, you can save monthly, and it’s pretty easy to understand. It’s the Roth IRA for college, right? You can use it anywhere. So, one criticism I’ve heard about people who are incredible savers is sometimes you can be in a position where you saved too much to a 529. So, obviously, that’s a wonderful problem to have. But say you put in a lot. You said that a 529 can — It can’t physically have more than $400,000 or $500,000 in it?
Jordan [00:42:20] Yeah. So this varies based on the state rules, but that’s around the max for many of them. So the case where you save too much is definitely pretty infrequent. Usually it’s the opposite problem.
Jordan [00:42:32] But, you know, if you are fortunate and you find yourself in that situation, you can do that kind of beneficiary change to a younger sibling, if you happen to have any who could benefit, or even grandkids eventually. That’s also an option. Otherwise, is there a higher education experience you’d like to pursue? That’s also an option that you could do.
Jordan [00:42:52] And then ultimately, as we were talking about earlier, if you do have to use the money for a non-intended purpose, then there is that tax and penalty on the earnings portion. But at least it was invested in the first place.
Travis [00:43:04] Do you know if 529s have any negative impact in getting financial aid?
Jordan [00:43:08] They do count as part of the expected family contribution. But if they’re owned by the parent, then it’s, I think, only around 5% is factored in. So, it is a relatively limited small factor in how much financial aid you get.
Jordan [00:43:23] You know, sometimes families worry that if you have any savings, then you’re going to blow your chance to get a full ride or something like that. That’s typically not the scenario that happens for families, generally. You know, a dollar saved is two or three dollars of debt that the kid’s not going to have. It’s kind of like a fairly universal law.
Jordan [00:43:42] And then, on the margins, if your kid is very needy and goes to a really well-endowed school, they may get a very generous package. Chances of 529 savings altering that package are pretty slim. So for most families, I wouldn’t make it a really significant factor in how you approach saving.
Why every parent should contribute a 529 plan
Travis [00:44:00] Cool. So, here’s the bottom line. If you have kids, especially if they’re young or if you’d like to have kids, everybody should be doing — Certainly everybody that has kids already should be doing $100 a month into a 529 for each kid. I think that’s a very good idea.
Travis [00:44:15] So, I had you on this show because I wanted to talk about 529s, not necessarily because I wanted to talk about your company or because you were paying us a bunch of money or something. But you did say something about our listeners could get a special discount, so maybe you can share that link with our listeners.
Jordan [00:44:31] Yeah. We did want to offer this for any families who’d like to get started. It’s basically if you visit CollegeBacker.com slash SLP, then you can get started with $25 on us and that’ll be redeemed right into your fund once you set it up. And then hopefully from there, you know, we’re just the first of many CollegeBackers that you can recruit and have supporting your kid.
Travis [00:44:52] That’s awesome. So, I think the idea there is get started. Put something small in every month. And ask your friends and family to contribute and see what the reception is there. I think it’s a really cool idea. I really hope you guys are successful.
Travis [00:45:04] The thing that I want our community to do is open the 529s. Get it started. Don’t just start it when the kid is 15 years old and expect [that] interest income is going to grow the savings a lot. You know, it’s just not going to have a big return if you start that late.
Travis [00:45:19] So, you know, my grandma — just to give a personal story — she bought us, I think, like, $1,000 of savings bonds when I was, like, brand-new baby zero, you know? And then I cashed them when I was 25. I think I got, like, $2,000 bucks. Like, double over 25 years. Right? And if she had put that into, like, 529 for my college or she just put it in investments in general, then she would have had maybe, like, $5,000 to $10,000 bucks. I mean, it would have been a lot larger, right?
Jordan [00:45:43] So, I just think that you want to be smart in how you gift money to people, and I think this is a great way to help family members be smart about it. So.
Jordan [00:45:50] Jordan, thanks so much for being on the show. Can you share where people can — obviously, the CollegeBacker.com slash SLP, if they want to open an account. But where can they learn more about you and your company besides that?
Jordan [00:46:02] Yeah. I mean, besides that, everything is on CollegeBacker.com. And I’m on Twitter at Twitter.com/JordanGLee. We have lots of information on our site, and we’d love to hear from your audience.
Travis [00:46:13] Cool. Well, thanks for being on the show, Jordan.
Jordan [00:46:15] Thank you so much.