As we are hopefully coming to a close with covid, I’m noticing something that I have not in a while.  I’m noticing that I’m getting a lot more questions about saving for college than I typically do.  I’m also noticing that a lot more couples are having babies than I’ve noticed in past years.  Upon doing the math regarding the lockdowns, the timing makes a lot of sense to me.  I’ll leave it at that.

So, let’s talk about saving for college.  There are a lot of choices on how to do that.  The one we will discuss today is a 529 plan.  Yes, there are other choices (Coverdell, Custodial Accounts, and several more), but for our purpose, I want to discuss a 529 plan and how it can benefit (and hurt) your college savings.  I also will discuss how you can overcome the disadvantages of the plans as well.

The good parts:  If God were to tell me that my kids would go to college, the market would go straight up, and they would not get any financial aid or scholarships, then I would put all of my money for my kids’ college into a 529 plan.  Unfortunately, God hasn’t told me such a thing, so I need to have a plan in case one or more of those things don’t happen.

With that being said, let’s discuss the benefits of a 529 plan.  It is a plan that you can put in “after tax” dollars and allow the money to grow tax deferred.  If the money is used for education expenses, the gains are tax free.  Also, depending on the state you live, you may be able to get a state tax deduction or benefit of some sort.  Every state is different, so check with your home state’s 529 plan for more information about that. 

The bad parts:  Now, let’s address what you need to know about these plans before you write that check. 

The first one is the fact that if you don’t use the money for educational purposes, the gains are penalized AND taxed.  So if your son or daughter doesn’t go to college, then it can hurt.  Keep in mind that if your oldest child doesn’t go to college, the money can be used for a younger sibling who does go to college without penalty. 

The second disadvantage is that there are limits on what you can invest.  Every state has their own 529 plan, and it is limited in their investments with mutual funds.  Now, you can invest in any 529 plan you’d like, however, if it isn’t your home state, you may not qualify for the state income tax benefits (which they all vary).  So, if you like mutual funds, this isn’t a big deal to you.  If you are not a mutual fund person, than this can be tough.

The final disadvantage of the 529 plan that I think is the most important one to address is the fact that the market doesn’t always go higher.  This is where options can play a part. 

The method that we used with our kids was we allowed for market exposure in the 529 plan but bought put options outside of the plan.  There were a lot of methods we used for such technique.  We used spreads, single leg options, as well as some timing.  We did not simply buy some puts and let them sit.  This is also a technique that you can use if you want to hedge stock exposure in a 401k. 

The most important component of doing something like this is having an understanding that you actually hope you lose money in the one account.  That is a tough pill to swallow for a lot of people.  The important factor of this is that you want to make sure you are losing money for the right reasons. 

For example, if you set up a position of “at-the-money” puts and the market never moves, you will lose based on time decay.  Your 529 has stayed the same, but your puts have lost you money.  That is not the way to win over the long term (although it is unavoidable at times).  That is why theta needs to be monitored very closely at all times.  How are you accounting for it?

If you have a put option account and the market increases significantly, then you are losing money for the right reasons in your put option account.  If it is set up properly, the gains in the 529 plan should significantly outpace the losses with the puts.

Should you decide to hedge your 529, make sure you do it by having a plan for all possible risks.  Time decay and volatility are often overlooked when people try to do this.  Don’t be one of those people. 

If you are interested in college planning or anything else we do, send me an email at mtosaw@rcmfs.com.