Outside the Box: I don’t know if my 3-year-old daughter will go to college, so would saving through my retirement account be more flexible than starting a 529 plan?

I’m a 17-year veteran teacher in the Bay Area of California. I plan to retire early (57ish) with 30 years of teaching under my belt. I will already have a guaranteed pension from CalSTRS but have saved approximately $25,000 outside of that in a 403(b), like a rainy-day fund. I plan to contribute very modestly into that account and assume I’ll have it up to $50,000 to $60,000 by the time I retire.

Because I will be separated from work already, I’m under the impression that I’m allowed to tap into it earlier than age 59 1/2. If this is the case, then I could withdraw whatever is necessary for college-related fees to support my daughter. My assumption is if she goes to college, she will get a part-time job and take-out minimal loans.

My fear in establishing a brand-new 529 plan is that despite all my years in education and being a pro-college parent, my daughter may not want to go the traditional college route. I would then be stuck with this 529, not having relatives to pass it on to, as their children are already well taken care of.

What do you think? Am I overreacting?

Sincerely,

Fear of the Future Mom

Dear FOTFM:

It is understandable that you are confused with all the uncertainties around college funding. Balance is the best way to approach major financial decisions, especially when there are so many unknowns., Different goals — retirement, a child’s education, savings for an emergency — have distinct time horizons, and the funds should not be commingled.

A cornerstone of good financial wellbeing is having money in a savings account to fall back on. Your 403(b) investment is not an emergency fund. If you have one, great. If not, start saving now with a goal of three to six months of living expenses.

A 529 plan is an investment vehicle for college, in your case starting in as little as 14 years. That is a much shorter time horizon — and therefore needs a different investment strategy — than a retirement account.

Why start a 529 plan now?

1. Increased likelihood of attending college. Children with even small college savings plans have higher college-attendance rates and are more likely to graduate from college than those with no savings. Don’t underestimate the positive psychological effects of beginning a college savings plan early in a child’s life. This motivates children academically and socially for college from a young age, so let her know part of her next birthday gift will go for college savings.
2. Flexibility. Rules have changed in recent years. Because you can now use 529s for private pre-college education, other schooling, like technical college, books, and room and board as well as college tuition, you and your child are not locked into just a four-year college. Most careers need some advanced education, so your daughter will be supported however she continues her education.
3. Tax-free earnings. Funds are invested in mutual funds and grow free from state and federal taxes. A 529 plan is funded through after-tax money, and withdrawals to pay school expenses are not taxed at all. Over 30 states have a tax deduction for contributing to a 529 plan. California is currently not one of those (attempts to add such a tax break have failed to date in the state legislature), but a 529 still makes more sense than saving any other way.

So start contributing now, even $25 or $50 a paycheck, and be ready for your daughter’s schooling. Starting small is reasonable way to establish a good habit, even with all the other expenses you are facing.

Read: These are 3 big mistakes you can make with a 529 plan

You are wise to have your daughter’s buy-in with working and minimal loans. Just be realistic about how much your daughter can work in college without it affecting her schoolwork and how much of the costs those earnings can cover. Tuition and textbooks cost a lot more than we were in school, and overall college costs have risen faster than the minimum wage.

Read: It’s nearly impossible to work your way through school

If that 529 plan is never used to pay for your child’s college education, the money is still yours.

You can use it for education yourself or someone else in your household or withdraw the money for other purposes. If it is not used for education, you will have to pay taxes along with a 10% tax penalty on the earnings only, unlike the taxes and penalties due on an early withdrawal from retirement accounts. If you give it to your daughter for another purpose, she will pay taxes, and that is most likely to be a lower tax bracket than yours.

As far as tapping into your retirement plan at age 55, you may be one of those who qualify to do so without penalty. Those who do not pay a 10% penalty before 59 1/2. You will still have to pay federal income taxes on it and possibly state income taxes as well, even if you are retired.  The tax hit leaves less for your daughter’s education.

Read: This is how you can withdraw from your 401(k) at 55 — without paying a penalty

Even with your pension, funding an IRA, 401(k) or 403(b) is still wise. You could easily live into your 90’s, so perhaps 35 years beyond your planned retirement date.  Inflation and health issues could erode the pension.  Having extra money may be needed.  So keep putting money in your 403(b), reducing your taxes today and giving you more in retirement.

Do not use that money for non-retirement expenses, including college costs, even if you have retired early.

Remember, you are planning for college expenses 14 years out. At that point, you may have a job you love within the California education system. Or you may work somewhere that will help with your daughter’s tuition. Or she may choose a different education route. Or part of college could be funded by the federal government. We just don’t know.

Rather than acting as if you know the outcome, fund the accounts with purpose today. In the long run,  you will be better prepared for whatever arises. This integrated strategy of financial wellness will serve you and your daughter.

CD Moriarty, CFP, is a columnist for MarketWatch and a personal-finance speaker, writer and coach. She blogs at MoneyPeace. Email your questions to MsMoneyPeaceQuestions@MoneyPeace.com

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