529 Plan or Rental Property to Fund My Kids College?

Question

In talking with a close friend of mine about my personal real estate investments in 2018 he informed me that he and his wife are seriously considering investing in real estate as opposed to funding a 529 plan for their children's college educations. He is looking at a 15 year timeline give or take. I thought I might pose the question here for some well informed opinions regarding the pros and cons for each. What should they consider in making the decision to fund a 529 or buy real estate?

Thanks ahead of time for your thoughts and opinions.

Ray Johnson · Answer

@Matthew Creel unfortunately for me I live in California, one of Seven states that do not allow a State tax deduction similar to what @Eamonn McElroy is referencing for 529 plans, so the decision was easy for me, If CA offered it I'd probably do both since I believe in diversification when it comes to all aspects of investing.

I purchase One property per child shortly before or after they are born, New construction or less than 5 years old, Class A or Class B product in high appreciation neighborhoods within major metropolitan cities/county's, South Orange County California, and Washington, DC. is where they are located, I also make sure they are near top colleges in case they choose to stay in them when they go to college which will save on housing.

Bill F. · Answer

@Matthew Creel I'm looking at a similar option for my kid. Here my thought process so far, but bear in mind its a work in progress.

RE

Pros: Same as any RE investment. Ability to use leverage to buy a solid appreciating asset that has some cashflow. Risk is controlled by the class of property purchased. Kid gets to college age, sell or get a LOC against the paid off property.

Cons: All your eggs in one proverbial basket. If something goes wrong timing wise (local down turn, job loss on your part, change to local gov ect) the asset may not make it to when they are ready for college.

529

Pros: Tax advantaged contribution (at some sate levels) growth (at the federal level). $200-500k contribution limit per account which can help you and relatives with estate planing via gifting, particularly via front loading the gift.

Cons: Lack of control for investments that have high-ish fees. From what I have seen and I could be wrong here, but most plans give you a limited menu of targeted date funds or a selection (5-15) of bond/equity funds to invest in.

Again there is no one "best" because both RE and 529 have tax advantages and by their very nature nature taxes impact everyone differently so you'd have to run the numbers for each and take into account your own specific tax situation to make a final determination. Your career track, earning potential, choice of secondary school,  ect will play a big role.

Your friend may also want to look into UTMA/UGMA accounts.

@Jay HelmsFrom Schwab

Key Points

• A 529 account can be used for other types of education besides college, including trade and vocational schools.
• As the 529 account owner, you always have the right to change beneficiaries to another family member – or even yourself.
• However, if you decide to use the money for something  other than qualified education expenses, you will have to pay income  taxes plus a 10% penalty on the earnings.

Eamonn McElroy · Answer

A little off topic, but the TCJA widened the scope of 529 plans.

They can now be used for K-12 education in addition to college.

Quite a big planning opportunity for families that send their kids to private schools...

Joe Splitrock · Answer

@Matthew Creel we have both for my daughter. We contribute to a 529 and when she was 3 years old we purchased a house on a 15 year mortgage. The house will be paid off when she turns 18 and is headed to college. We can either use the paid off cash flow or sell the property.

Peter B. · Answer

I switched from 529 to roth Ira. I pay my boys as employees, and have contributions automatically deducted from their savings. They are 8/9. They will have the option in the future to use this towards real estate if wanted..

We did and still to do (just not as much) the 529. I didn't care for education only and just the state deduction, So we switched.

Jay Helms · Answer

What if your kids don’t want to go to college? What will you then be able to do with the 529?

Nadya Ostroff · Answer

Rules of 529 plan can vary  (state specific). For example, some states allow to use it only for State schools, it also can count against your kid when he/she applies for financial aid. Anyway  from what I understand, more people are trying to get a rental ( as soon as child is born preferably :), keep it for the 15 or so years, then sell it and pay for college.

Ashish Acharya · Answer

You should do both if you can. 529 plan acts as a retirement plan if your child gets a scholarship, meaning there is no 10% penalty if you withdraw for personal purpose.

Eamonn McElroy · Answer

@Matthew Creel

529 plans are definitely worth consideration.

While you don't get a federal deduction for contributions, you do generally get a state deduction on contributions, tax deferred growth, and eventual tax-exempt withdrawals for qualified expenses.  That's a hard bargain to pass up.

I believe the maximum deduction Alabama allows for their 529 plans is $10,000 a year if married filing joint.  At Alabama's 5% marginal income tax bracket, that's an additional $500 in your pocket annually just for making the contribution.

Very good question for your friend's financial advisor who should run a model to see what's better based on his facts, circumstances, goals, and assumptions.

Max T. · Answer

I kind of do both. Buy rentals every few years and pump some of the cash flow into the kid's 529, my IRA, etc...

529 Plan or Rental Property to Fund My Kids College?

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