“I can’t contribute more to the TSP because I have kids in college.” Those of us who urge federal employees to set aside money for retirement have heard this line more times than they can count. It’s true that there are goals other than retirement for which we want to save. But we neglect retirement savings at our own peril.
Many people will attack their financial goals in a chronological sequence. For example, a person might first save exclusively for their children’s college education and not set money aside for retirement until they have completed funding college for their children. This puts their retirement savings at a disadvantage due to a late start.
We should harness the “time value of money” for all of our savings goals. To take advantage of the time value of money, we need to begin saving early. For retirement, a FERS employee (or a uniformed services member who is covered by the Blended Retirement System) should always contribute at least 5% of their salary to the Thrift Savings Plan in order to get the full employer match. This is a great first step and, over a full career, will provide us with a nice nest egg that will supplement our FERS annuity and Social Security.
Let’s now look at the time value of money when it comes to saving for college. The minute a child is born, it can be reasonably assumed that in eighteen years the child will likely be entering a college or a university. So why not begin saving for the child’s future college from the time they are born? You can do that with a 529 plan or a Coverdell ESA.
A 529 plan is legally known as a qualified tuition plan and gets its name because it is authorized by Section 529 of the Internal Revenue Code. All 50 states and the District of Columbia offer 529 plans. In addition, many colleges and universities sponsor prepaid tuition plans. Check with your state of residence to see what plans are offered.
The two main types of 529 plans are prepaid tuition plans and education savings plans.
An education savings plan is sponsored by a state government and may have residency requirements for savers. The plan is opened by a saver for the benefit of a beneficiary (typically a child or grandchild). In such a plan you would save for the beneficiary’s future qualified higher education expenses (tuition, mandatory fees and room and board). Qualified expenses include up to $10,000 per year at any public, private, or religious elementary or secondary school. The SECURE Act allows up to $10,000 of 529 money (lifetime limit) to be used to pay student debt. Generally, in an education savings plan, the saver can choose from a range of investment options, frequently including target-date funds.
A prepaid tuition plan will let the saver purchase tuition units (or credits) at participating colleges and universities at current prices. Prepaid tuition plans do not allow prepaid tuition at elementary or secondary schools and are generally for in-state and public colleges and universities.
A saver should be aware that, like with all investments, there are fees and expenses associated with 529 plans. Prepaid tuition plans may charge an application fee and ongoing administrative fees. Education savings plans may charge an application fee, account maintenance fees, asset management fees and other fees. If you were to google “529 Plans”, you would find more information than you could ever need on this topic.
Coverdell ESAs (education savings accounts) are similar to 529s, though they have an annual contribution limit of $2,000; this limit applies to all Coverdell accounts. Like 529s money in a Coverdell ESA can be used for both college and eligible K-12 expenses.
There are income limits on who can open a Coverdell ESA. For single filers, if your MAGI (modified adjusted gross income) is under $95,000 you can contribute the full amount and if it’s over $110,000 you can’t contribute at all. For joint filers, the numbers are $190,000 and $220,000.
Unlike 529s, Coverdells have age restrictions. The designated beneficiary must be under the age of 18 and the account must be totally disbursed by the time the beneficiary in 30.
Saving for your child’s education should not derail saving for your retirement. Start early saving for both of these goals. Consider a 529 plan for your child’s education and keep funding the TSP with as much as you can.