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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
People don't realize this. When it comes to tax law, they just say, oh, this is how most people do it, and they just assume that that's just how it is. There's no other ways to get money in there. There are. You just need to be aware of them.
Mike:Welcome to the Retire On Time podcast, a show that's all about not oversimplified advice, but the nitty gritty. We wanna get into the details here and not gloss over the general idea of retirement. So get your pencils ready. Let's dive in. As always, remember, this is just a show.
Mike:It's not financial advice, so please consider everything we say with a grain of salt, but you can always text your questions to (913) 363-1234, and we'll feature them on the show. David, what do we got today?
David:Hey, Mike. Are five two nine plans the best way to fund grandkids' education?
Mike:Best is a very subjective matter of opinion, kind of, you know, inference there. Yes. But it is a good way for some people.
David:Alright.
Mike:I like that.
David:It's good way.
Mike:I should be a politician.
David:A good way for some people. You could just put that on almost anything.
Mike:Yeah. Yeah. So five twenty nines are are nice in that you can put money into the account. The account can grow tax free, so it's not disrupting your taxable taxable situation. Situation.
Mike:Alright. Alright. So these are typically brokerage account funds. And you might say, well, I'm gonna grow my assets and then I'll pay the kids college. But when you sell your assets, you're gonna pay capital gains.
Mike:As you're trying to grow it, you might pay capital gains along the way. What if you just put it into a five twenty nine plan and then let it grow there, and it almost shields you from any tax situations. It grows tax free. It pays qualified costs or expenses tax free. It's kind of a nice bit there.
Mike:And if you don't use it or if the beneficiary of the five twenty nine doesn't use it, it's somewhere around 30,000 can be converted to a Roth IRA for that beneficiary for the retirement. So that's kind of a nice, like, end of Yeah. End of concept, end of five twenty nine plan concept. Couple of nuances to look at. Not all five twenty nine plans are the same.
Mike:Oh. Every state has a different five twenty nine. Some states will only only allow you to fund it if you live in the state. Others, they don't care where you live. You're just gonna fund it under under their plan.
David:And so who owns the actual plan?
Mike:Well, I mean, it's it's controlled by the state, but you would own it.
David:Okay. So the so whoever's starting it, like, and initiating it and putting the cash in, like, they own it. So grandma or grandpa owns the the account?
Mike:No. It's the beneficiary. The beneficiary the
David:Okay.
Mike:So but people can fund the account.
David:I see.
Mike:So grandma grandma can fund it. There are so the funding, this is a common misconception.
David:Alright.
Mike:So kinda thank you for for bringing that up. Alright. Funding a plan has limitations mostly centered around the gift tax limit. Ugh. So every year, there's only so much money you can put in before you have to pay a tax on the gift because money going into a $5.29 is considered a gift.
David:And this is like a federal IRS rule.
Mike:Yeah. Okay. K? So now now put that on a a, you know, a pedestal here for
David:a second. Back pocket.
Mike:The five twenty nine plans have an kind of a workaround that you can overfund it. So you basically put five years of funding upfront so it kinda gets more money in there so you can grow at a faster rate at or not a faster rate, but you'd rather get all the money in there and let it grow than having to kind of dollar cost average in. So if the markets are just going up, it's better to put all the money in upfront. Mhmm. If the markets are going down, it'd be better to dollar cost average in there.
Mike:But whatever. Yeah. You can overfund it. There's a form you'd fill out just declaring that you did it so you're not taxed on the
David:gifts. Okay. Okay.
Mike:Now that said, and this can change, so this is why you always check with a someone who understands tax law.
David:Mhmm.
Mike:K? You could overfund it and not care about this five year rule workaround, but just gift more because the five twenty nine plan is a maximum amount that can go into a five twenty nine plan. But instead of it being a gift tax limit or it being the five year funding, you can do a form seven zero nine of the IRS code where you're basically gifting to the five twenty nine plan part of your estate exemption limit, which is like $12,000,000. So if you wanna give and again, you check tax code in your in your state if there's any nuance with the state. Like, there's do not take this as blanket statement advice here.
Mike:This is these are interesting points to ask questions about. Alright. You could just overfund it, fill out form seven zero nine, and you're done in one year if you wanted to. So if your grandparents wanna overfund it, great. I that's kind of a cool way.
Mike:People don't realize this. They don't when it comes to tax law, they they just say, oh, this is how most people do it, and they just assume that that's just how it is. There's no other ways to get money in there. There are. You just need to be aware of them.
Mike:Okay? So now the problem with overfunding a five twenty nine plan is if they don't use it, then you're taxed 10% on on what's not used, and it's kind of a crappy situation to get out. You could change the beneficiary to someone else, and then they could use it. It gets kind of sticky. So do you want to put a half $1,000,000, which is kind of the limit, into a five twenty nine plan?
Mike:Probably not.
David:Okay.
Mike:But if you wanna overfund it or fund it quickly or something like that, there are several ways you could go about doing that. Most people will just slowly fund it because the you know, you got eighteen years before the kid's going to college unless you're some savant and you're going to Harvard at 16 or something. Uh-huh. I shouldn't say Harvard's like politically triggering triggering for some people. What's a good say?
Mike:Kansas State.
David:There you go.
Mike:Yeah. That's a safe school or KU. Yep. Another safe school.
David:That's School. Very good. Love those.
Mike:Local plug.
David:Yeah. Love those schools.
Mike:They haven't made the the national attention as of late, so I think we're okay there.
David:Yes.
Mike:Anyway. Now that's the traditional kind of general way that you would fund someone's education. My heartache with it is that it's what you can spend on is controlled.
David:Oh, by who? Who? Well, the rules. Oh, yeah.
Mike:So you can have, like, these expenses, but not those expenses. Right? And if if your child does the traditional educational route, probably fine. Probably not a big deal. Maybe I'm just being overly cautious here.
Mike:Okay? Before I actually continue, one last thing on five twenty nine plans. Uh-huh. Shop around. The the states that allow anyone to put their money in there, look at their investment options.
Mike:Some five twenty nine plans will have arbitrary you just you pick a portfolio and are very conservative, very steady Eddie, kind of boring in my opinion. And other ones will say, yeah. You here's the different ETFs, basically, you can pick from with the different funds. It's not just like a a basic ETF you can buy. They're like, they're special versions of the ETF, so they work for a $5.29 plan, but it's basically like you could buy the S and P 500 or something like that.
Mike:So I would, you know, find your favorite AI
David:Mhmm.
Mike:Or Google search, and compare plans to the state of Nebraska. Oh. Or neighbors. Personally, Nebraska is my favorite. Oh, okay.
Mike:And the reason is low cost, easy. They have two different versions of plans, so two different custodians that you could sign up with. And you could just put it all in the S and P 500 if you wanted to. Now, that's kind of a riskier move if you consider, like, your kid's gonna be in school in five years from now.
David:Okay.
Mike:But if you got eighteen years, that might not be that bad of a deal. And then there's other funds that you could manage it as well, but you're able to make you're able to rebalance portfolio, I believe, a couple of times a year.
David:Mhmm.
Mike:You know, check the the the documents to make sure that this isn't outdated information. But hey, Nebraska.
David:Mhmm.
Mike:It's my favorite 05/20 nine plan because it doesn't force you into an arbitrary portfolio. If you kind of know what you're doing, at least a little bit, you can get more aggressive trying to grow the asset. Shop around. That's it. Now Shop around.
Mike:If you want to take a different route, you could do trusts. So you put money into a irrevocable trust that's for the grandchild. I'm not gonna go too deep into this, but you set the rules on how they can use it, how they can't use it. But it allows you to define things as you want them to be. So it might be, you know, you know, talk to an attorney about this.
Mike:We're not attorneys. But it might be, hey. They it can it works for education, and if it doesn't work for education, then after education, they maybe they can use it for a down payment on their house.
David:Up to
Mike:so much in here. Maybe it helps with their retirement. Maybe it's their emergency fund. Maybe we're gonna use this to pay for their term life insurance. Maybe we're that they can use it for their kids.
Mike:You can define how you want the money to be used and restrict them so they're not, you know, trust fund kids. Okay. But it helps buffer them in a time that's affordability is more and more difficult for the younger people.
David:Uh-huh.
Mike:I know people hate about that complaint. It is a factual statement that is more difficult to live the traditional American dream today than ever before. Now, does that mean that they should act like victims? No. We acknowledge reality as it is, and you adjust your strategy to then overcome it.
Mike:That sounds fair. So you can't expect to work at a grocery store or in retail and get paid as if you're a tech developer. Yeah. It's just a different world. There are greater divisions based on your career path that you take.
Mike:Yeah. That doesn't mean everyone needs to be a tech developer. It means you need to be you need to be smart about the decisions you make in your career path or who you marry, and it's their career path if you wanna be a trad family. Did I say that the right way, the trad family?
David:I think so.
Mike:The traditional the nuclear family, as I was told in school. Right. Right. And
David:so if if the trust is irrevocable, that means it can't be changed later. Right? Yeah. Yeah. And so you as the person who's starting the trust
Mike:do a revocable trust and then later becomes irrevocable. This is why you consult consult an attorney.
David:Okay. Yeah.
Mike:Different laws, different states. Yeah. We're not attorneys, not given legal advice, but a trust allows you to well, let me tell a story. Wanna hear a story?
David:I love a good story.
Mike:So a friend of mine, really I mean, a good high school friend, I hung out with that family all the time in high school. This is, you know, twenty some years ago or whatever. Alright. Twenty years ago. No.
Mike:Anyway. Some number of decades ago. Around the year of 2000.
David:Okay. Yeah. I remember that year.
Mike:When we figured out that computers weren't gonna go berserk Yeah. Because the dates clicked
David:on January 1.
Mike:Do remember that?
David:I do remember that. Yeah. Everyone was scared.
Mike:So good good friends of of of mine throughout high school, and she was the youngest daughter of the family. So I hung out with them all the time. It was a great time. Parents were just wonderful people. And we were just chatting once at dinner.
Mike:I was over there visiting. And they were talking about how the oldest daughter had a that all the kids had trusts. The oldest daughter had a trust and came in and said, I want my money. And and the dad says, well, hold on. Yeah.
Mike:You know? Not that simple. What are gonna use it for? She says, well, my money. I can do what I want.
Mike:She says or he says, no, it's not. And pulls the document out. Says and explained what the money was for. See, the daughter the the eldest daughter wanted to run away with her boyfriend and be a beach bum. Oh.
Mike:And there was reasonable amount of money. They could probably do it for a couple of years and be very comfortable. Uh-huh. Said, nope. That's not how it works.
Mike:You don't get the money unless these things were were met. Okay. And thank goodness that document was there. The relationship yeah, they went off or whatever. I think they like wore beach bums for like a month or something.
Mike:I don't remember exactly. But they eventually broke up. It didn't work out. She then I mean, there wasn't anything weird about the relationship. This is a very normal, like, you know, in your your early twenties, you you have a rebellious bone in you.
Mike:So she eventually goes back to school, finishes college, marries this incredible guy. They both have incredible careers, have an incredible family. All is well. Right? Yeah.
Mike:The document protected her from making dumb decisions before your your your brain is even developed. Yeah. Who expects anyone 25 or younger to make a smart decision? We make smart decisions, but your brain isn't even fully developed. It's insane what we let anyone do.
Mike:Mean, anyway, so that's the point of the trust. So that's one option. You can just ignore the five twenty nine and set up your own version of it. The last one, which is is what I like, is is to use life insurance for this. Now hear me out.
David:Okay.
Mike:K? Do you know how cheap life insurance is for a two year old? I can imagine that it is. They're not concerned about death anytime soon. Yeah.
Mike:No. So the cost of insurance if you shop right, the cost of insurance is very, very low. If the cost of insurance is low, then your cash value has more growth potential. Now in in IUL's, for example, indexed universal life, you you would have you still have to fund it over a certain period of time. So for me, it's like, okay, fifteen years, you know, starting at three, they go to 18 years old.
Mike:I own the policy
David:Mhmm.
Mike:Or you would own the policy. K? They're the beneficiary of it.
David:Okay.
Mike:You with me so far? Yep. The cash value is growing. It's principal protected, so it's it's hedged against a flat market cycle. It has reasonable upside growth.
Mike:Is it gonna grow as much as the stock market? On the good years, not a chance. On the bad years, who knows? Because there are some protective components in there. But the reason why I like this is I'm controlling it.
Mike:Any distribution is tax free. And then I get to decide, and I I have a written document, so it's not a trust. It's not a legal document, but it's like, here's how it's intended to be used. So if you wanna be an entrepreneur, okay. I can take some of the funds out and have you have a go.
Mike:You can't really do that with the five twenty nine plan. If if you got scholarships completely paid for, the five twenty nine plan becomes slightly more useless. I say slightly, things can evolve or change in different ways that you could structure the scholarship and maybe use the five twenty nine plan. Maybe and that's a whole thing unto itself. I just wanna have a blanket statement there.
Mike:But maybe they use the or the the life insurance for just their sabbatical year and they do some some world travel. I think if you can leave this country and see how the rest of the world lives, it is a very sobering experience Yeah. That not enough people get. And I'm not saying go to, you know, England and France and, you know, do your your hoity toity, like, you know, get some nice food, see some West End productions, and then go to France and have these nice, you know, cuisine or what. I'm saying, like, go to the poor countries and serve and see how the world really works.
Mike:That will sober you up. Yeah. So anyway, you can do that with the cash value because you decided to do so with the life insurance as opposed to a $5.29 plan. You could also do this with the trust as well. It's just easier for me from a just that standpoint.
Mike:Anything I say goes at that point. And then when they become a smarter enough adult, I can then gift them the policy. So you do have the the the cash value, the value of the policy, it is a an event. So you have to fill out form seven zero nine and and basically transfer the ownership of the policy. So it could exceed the gift tax limit, but you could transfer the policy owner to where they own it.
Mike:And now guess what I've done? I've paid for their term life insurance, basically, life. So that's one one less expense. The cash value can help them with their down payment of their house. It can help them with their retirement.
Mike:It can help you with their emergency funds. So if they keep if they're smart about it, they can keep the funds there for their rainy day fund, and it continues to grow and so on and so forth. So I like that because from an administrative standpoint, it's a little bit easier than the trust. The trust is a great option for certain situations. This is a bit more open as long as the kids develop healthy relationships with money, and they don't just go blow it all and blow up the policy because that can be an issue.
David:Mhmm. Does the trust have non qualified or qualified money in it? How does how do
Mike:you plan? Question. Non non qualified.
David:Oh,
Mike:okay. Because remember, qualified money retirement accounts are individual retirement accounts. They're for the person. So you're not really transferring assets over there. Right.
Mike:People people all the time, but let's fight with IRA money. You can do that. You're gonna pay taxes on it. So we might like, you can do beneficiary IRAs and say, well, I need to take it out anyway, and then put it to different types of accounts, different places. That would be fine.
Mike:But you're gonna pay taxes on the money leaving a qualified account. Trusts and and life insurance, those are after tax funds brokerage account, think your checking savings, and
David:so on. And the and the five two nine, does does money go into a five two nine after tax Yep. Before? Okay.
Mike:After tax as well.
David:But then it can come out with no
Mike:It's like an educational version of a Roth.
David:Oh, I see. I see. Of a Roth.
Mike:Yeah. And so you just you wanna think about it from a you don't wanna pay or help pay for someone's college that creates a tax issue if you were to sell it and then move on. They're not a charity. They don't qualify as a five twenty nine plan. Yeah.
Mike:So instead of you disrupting your tax planning, you can defer part of the money over not defer from a legal standpoint, but you're moving money over to a five twenty nine plan, let it grow tax free, pays out tax free, maybe part of it turns into a Roth.
David:I see.
Mike:It's a path. Yeah. Now each version is right for different people for different situations. That's why you have a conversation, you explore the benefits and detriments, and you proceed as it makes sense for you. So don't love or hate one of them because of what you already know.
Mike:Ask questions like, what if? Or what is it that I don't know that would change my opinion about a particular strategy? It doesn't mean you have to love that strategy, it means you understand it as it is. And then once you can clearly define what things are, then you can decide the right tool to use for your goals. That's all the time we've got for today's show.
Mike:If you enjoyed it, consider telling a friend, leaving a rating, but make sure you subscribe to it as the bigger that the YouTube channel gets, which is the best place to enjoy this content or wherever you get your podcast. The bigger the channel gets, the better the resources are for us to then get to you. As always, don't forget to go to retireontime.com for additional resources, calculators, join one of our workshops, and so much more. That's retireontime.com. But from all of us here at the Kedric Wealth Studios, we wanna thank you for spending your time, your most precious asset with us today.
Mike:We'll see you in the next episode.