Other Airline Depreciation for Delta Air Lines

Delta Airlines, for the moment, has not recorded decreases in their substantial investments in foreign airlines. As we approach their 10Q for Q2, there is a possibility that some or all of the investments which are worth much less now than prior to February, 2020 will be posted as a special liability on their balance sheet. Below is a table that specifies each of their other airline investments, and the fair value of those assets as it stood on May 20th. The total off book loss is just under $1.7B. 

***Note that since I first published this, LATAM has filed bankruptcy, effectively wiping out the $2B that Delta had invested in the Brazilian carrier over the past several months.


Virgin Atlantic(in millions)    
Percent OwnedCarry Value 2020Carry 2019Current ValueNegative (Positive) Differential
Grupe Aeromexico
Air Fraqnce-KLM
China Eastern
Wheels Up
Total Investment Deficit off book



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COVID-19 Economic Forward Projections

We are in an uncertain time—perhaps the most uncertain time to occur since the Second World War. It is difficult to determine via anything other than wild guesses what will occur on a broad social level over the course of the ensuing year. It is in this sort of environment where confident, highly specific outlooks should be viewed with a pronounced degree of skepticism. Rather, there is a broad range of possible outcomes that range from fairly likely to nearly impossible.

“This is not the time to act as though there is any certainty. When in a state of uncertainty, the best thing to do is to diversify your economic life in anticipation of the most likely subset of possible outcomes.”

Any rebound in COVID-19 infections will be handled in a timelier manner than in the past, with an increasing arsenal of medical tools to effectively combat the virus. Unfortunately, we can also predict a high likelihood that the infection will eventually rebound, and that new hot spots will emerge. The public response if this occurs will be more timely and effective following several months of COVID-19 saturating public attention.

Our model also assumes that a vaccine will be in productions phases for widespread distribution sometime late winter/early spring of 2021. Given recent indications of progress in the process of developing a coronavirus vaccine, this seems like a reasonable timeline, though as we evaluate the “forward economic trajectory” curve, we are actually looking at several different interrelated curves of differing probabilities: for example, the odds that public response will be more effective following several months of experience with COVID-19 is highly likely, and will sharply drop off towards the tail end of “completely inadequate public response”; the “vaccine timeline” curve will be much more gradual towards the edge of “longer than spring of 2021,” while being much more sharp (i.e. unlikely) as we move it backwards into towards 2020.


So what is our “fat part of the curve?” The most likely forward path of COVID-19 will include continued hyper-media coverage of the virus; every bobble and transient spike will be covered with the standard flair of click-bait titles. With an entire country (and world) at play, there should be never ending fodder for apocalyptic coronavirus coverage.

Summer will not end coronavirus, but all indications are that it will contribute to flattening the curve. This is good news for the immediate future, but the downside is that colder weather in the fall will most likely see a resurgence in COVID-19. This has a real possibility of stretching “track and trace” methods of containment to their breaking point: in some locations this may well result in localized containment strategies (i.e. quarantine). Still, with quick testing capabilities having caught up to demand, and the opportunity to staff up for “track and trace” operations, it seems reasonable to think that we will largely be able to ensure that medical services are not overwhelmed.

All of this means that a sharp economic recovery into the summer months is quite possible, though short-term the recovery will be blunted by the overhang of an inevitable October resurgence. The final economic recovery will likely mirror other recessionary recoveries in slope, and should follow the availability of an effective vaccine. 

Feel free to contact me directly if you have any questions, and follow me on Twitter for up-to-date information on market conditions.


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Post-9/11 Airline Demand

I am linking my research in a table below. The first table calculates the percentage impact on air travel due to the terrorist attacks of 9/11. The table tracks the months that followed from September of 2001 until the end of 2005. The Domestic numbers are on the left column, International on the right. The percentage table references the month-by-month comparison of passenger enplanements from the rolling twelve months prior to 9/11. The video below describes the tables in more detail.


Domestic % of 2000-2001 International  

Great Recession Airline Demand

The second table tracks passenger enplanements following the effects of the Great Recession. The percentages reflect the monthly numbers in the rolling twelve months prior to the decrease in passenger traffic. It is interesting to note that international travel, with few exceptions, was at or greater than pre-recession levels throughout the period.

Domestic % of 2006 International % of 2006

Below is a graph of the Demand Curve for airline travel through the period of mass shut-ins and economic closure. The tail end of the graph shows the initial return of demand, on an apparent exponential trajectory. 

The following graph shows what the combined effects of both the Great Recession and 9/11 would have been on airline demand. The scale on the x-axis is in months. The percentages are based upon peak demand levels prior to the demand disruptions.

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Making Your Money Work for You

This article is not about credit card debt. It is about what you should do with free cash flow and savings after you have paid off any outstanding high interest rate debt. Yet since the statistics indicate that many people perpetually float high interest rate debt, I always begin with an appeal to my clients to start by paying that off. Once high interest rate debt is no longer an issue, we can get down to the details of where to put your money. The first step in this process is to consider the different investment accounts, and their benefits and limitations. 

Financial Advisor

Stan Dunn

“The first step in financial freedom is getting rid of bad debt. Any debt that is charging you over 10% is bad debt. Your best investment is to pay that debt off with your individual free cash flow.”


If you have cleared your financial life from the burden of credit card debt, congratulations: by far the most reliable investment is the one that eliminates 18% interest rates. Warren Buffett himself cannot maintain anything like 18% returns on an investment.

If you have never had a problem with credit card debt, keep on the good path. Either way, if you have begun to accumulate cash, it is time to figure out what to do with it.

If you are spending less than you are making. In business terms, you are in a state of free cash flow. This is the first requirement to build up savings. It is actually the most important step, in that investments mean nothing without some unencumbered cash first.

Savings Options

I have written about why savings accounts are horrible places to keep cash long-term. The nuts and bolts of the argument is that, in the modern era of near-zero percent earnings on savings account funds, any cash that you hold long-term is all but guaranteed to depreciate. A dollar tomorrow does not buy as much as a dollar today. Holding cash is (to a much lesser extent) similar to credit card debt: you are paying interest (depreciation is effectively an interest rate charge on held cash), which buys you nothing, earns you nothing—is, really, good for nothing. (I should note here that holding cash during certain market conditions can be an effective investment strategy. Letting it build in your savings account without a second thought, however, is no strategy at all.)

If you could track a dollar through your bank account, the ideal would be that very few of those dollars would sit for more than a few weeks before being spent. This is not an appeal to consumerism or reckless spending: the point is not a justification to blow your cash, but to protect it by investing it responsibly. If you have too many dollars sitting idle, you need to start thinking about how to make that money work for you.

Most likely, that is why you are here.

Brokerage Accounts

The most flexible option for savings is to open a brokerage account. There are dozens and dozens of options. The landscape of brokerage accounts is large and competitive, and so most of the accounts offer free trades on stocks and ETFs, and low fees for options and futures.

There are several sites that give an overview on the various brokerages and their fee structure. Do not get too caught up in trying to find the perfect option: there are generally only slight differences, and changing from one brokerage to another is rarely ever difficult. Find a particular brokerage that seems to fit your needs and that you feel comfortable with, and open an account.

Many brokerages have no minimum requirement for account balances, so even if your excess cash is only a few hundred bucks (or you want to start off small until you get more comfortable) it is not an obstacle.

I will not get into the details of the process of buying and selling different investment options here—I cover that in another article and video. For now, the important thing to focus on is whether a brokerage account is right for your particular situation.

The biggest advantage to a brokerage account is the ease with which you can move funds in and out of the account. If you want to maintain a rainy day fund, a brokerage is a great place to do it: if you invest the money conservatively, the risk of loss will be low, while it should also be easy to maintain the purchasing power of your savings by getting a rate of return that at least covers inflation. For a touch more risk you can even make a few extra bucks—that is, your savings next year will buy you more than your savings would right now. This is the act of putting your money to work.

While the flexibility of brokerage accounts is its main selling point, taxes are its greatest downside: as in you generally must pay taxes on your earnings. There are two types of taxes on capital gains: long-term and short-term. (There is also what is called 60/40—where 60% of gains are taxed at the long-term rate, 40% at short-term—which is applicable to options and futures trading.)

Capital Gains: Long and Short Term

A long term investment, according to IRS logic, is any investment that a person owns for more than a year. Short-term is anything owned for less than a year. The tax rules are fairly straight-forward from there: long-term capital gains are taxed at one of three different levels: 0%, 15%, and 20%. Your income determines the tax level: for single-filers making between $40,001 and $441,500, the rate is 15%; for married joint-filers the 15% rate is for incomes between $80,001 and $496,600. Below these rates capital gains is 0%; above it the tax is 20%.

Short-term investments (those owned for less than a year) are taxed at your normal tax rate (since it is earnings on top of your regular earnings, the rate will equal your highest marginal tax rate). In all cases, the short-term capital gains rate is greater than the long-term rate: the government wants you to invest long-term.

Dividends on stocks are taxed at long-term rates as long as a few qualifications are met. And if you buy an ETF or mutual fund that reinvests dividends, you will not owe any taxes until you sell the ETF or mutual fund for a gain. If you hold onto a fund for a significant amount of time, the advantage is that you will earn interest on the full amount of the dividend, instead of only the portion that is left over after it has been taxed.

If you are in the 0% capital gains long-term rate (and you are not planning on buying or selling investments more than once a year) brokerage accounts have a great deal of flexibility without a serious underlying cost. If you are in the 15% or 20% bracket, you can consider the cost of a brokerage to include the tax burden that the government applies to your earnings. And do not forget to check your state to see if they tax capital gains as well.


By far the most popular retirement savings plans offered by employers are 401Ks. There can be significant advantages to 401K accounts: earnings are tax free while invested in the account, and there is no tax penalty applicable to short-term investments. And while retirement accounts generally have maximum annual amounts that can be contributed, 401Ks are relatively quite generous: individuals are allowed to contribute up to a maximum of $19,500 in 2020; adding employer contributions, a total of $56,000 can be contributed annually.

Which brings us to the next great advantage of 401Ks: many employers offer matching funds. With a 50% match, for example, the employer will deposit fifty-cents on every dollar of employee contributions. 100% would be dollar for dollar, and so forth. This represents free money, and perhaps the only circumstance where you may want to delay paying off a credit card in order to maintain those matching contributions: those 18% credit card interest rates will eventually eat you up, but it’ll take a few years before they cover the 50% or 100% (or whatever your particular employer offers) gains on matching 401K plans.

401K accounts suffer from a general lack of investment options (each employers plan is different, but no 401K plan provides the variety of investment options a brokerage does), and they suffer from limitations in flexibility: if you withdraw prior to age 59 ½ from a 401K, with a few exceptions, you will have to pay a 10% penalty to the IRS, and withdrawn funds will be added to your income for the purposes of tax—no matter how long you have held your investments, they will be taxed as short-term in the event of an early withdraw.

401K money has minimum distribution requirements once you turn 72 ½ (or when you retire – if your particular plan allows this). The IRS publishes the RMD (required minimum distribution) table online. Penalties for failing to withdraw from your 401K in accordance with these tables incurs significant penalties, so be sure to pay attention to it.

Roth vs Traditional

There are two kinds of 401K accounts: Traditional and Roth. Not all employers offer Roth 401Ks, but they are becoming more and more common. The difference between the two relates to when tax is paid: in a Traditional account, contributions are pretax—meaning that your taxable income is decreased by the amount that you contribute to your 401K. The 401K funds remain untaxed until you begin taking distributions, at which point they are counted as income and taxed normally.

Roth 401K contributions, on the other hand, are contributed after-tax. There is no tax benefit on the front end, but there is once you begin to take distributions: in retirement, the money is tax free. The general rule of thumb is that if you anticipate your taxes to be more in retirement than they are now, contribute to a Roth.

Note that using this tax measure for picking a Roth or Traditional 401K assumes that you add the tax savings from Traditional contributions into your 401K. If you do not contribute extra money in an amount equal to your tax savings, Roth savings will always outperform for retirement. Many people, for example, contribute the amount that their employer matches (i.e. if an employer matches up to 10% of contributions, many people simply contribute 10% regardless of whether it is a Traditional or a Roth plan). There is no reason to stop investing at your employers matching limit (and you should ALWAYS contribute at least as much as they match), but if you are going to contribute the same amount regardless of whether it is before or after taxes, put your money in a Roth. Your retirement self will thank you.


IRA accounts are often confused with 401Ks. While 401Ks are employer sponsored plans, IRA’s are self designated retirement plans. The contribution limits applicable to 401K plans are separate from IRA’s, so you can contribute the maximum allowed to both a 401K and an IRA (though not to two different kinds of IRA’s: if you have more than one IRA, the IRS contribution limits on IRAs is cumulative across the IRAs).

IRA’s also come in two flavors: Traditional and Roth. With few exceptions, Roth IRA’s are preferable to Traditional. There are two major reasons for this: since funds contributed to a Roth IRA have already been taxed, if you need to withdraw the principle from a Roth IRA due to an unexpected need, you can do so penalty and tax free at any time (this applies to a cash contribution: rollovers must be held in the account for 5-years before the principal can be withdrawn without penalty). Distribution of earnings on a Roth IRA prior to 59 ½ (or five years after making contributions, whichever is later) will be subject to 10% penalty and taxes.

The second reason that Roth IRA’s are superior is that there are no required minimum distributions in retirement. In other words, if you were able to cobble together $1,000,000 in a Roth IRA between contributions and earnings, and you were earning 5% in interest and dividends on the money in retirement, you could distribute $50,000 per year tax free. With no RMD, the Roth IRA earnings are never exposed to taxes.

The implications of this perpetual tax free status are highly dependent on the scope and terms of your planned distributions over the course of your retirement, but in pretty much all instances the Roth money will outperform Traditional, dollar for dollar. For example, if you utilize the IRS distribution tables you will be withdrawing around $65,000 from a traditional account the year after you turn 72 ½. Assuming you began with $1,000,000 in an IRA account, and factoring in inflation every year (so that your income increases by 2.5% every year to give consistent purchasing power), and assuming that you earn 5% on the residual savings every year, you will run out of money when you are 91 with a Traditional account.

Over the course of those years, you will have distributed $1,214,039 (after taxes) from your Traditional account. With a Roth IRA you would only have to withdraw $50,700 in year one (Roth distributions are tax free; assuming a 22% marginal tax rate, $65,000 in a taxable Traditional IRA distributions equals $50,700 in tax-free Roth). Adjusting for inflation in the same manner as with the Traditional funds, you would run out of Roth funds when you are 98. Over the course of those years you would have distributed $1,869,152: this is $655,113 more than the Traditional IRA.

On your original million bucks, this equates to around 2.5% per year additional earnings in retirement. It does not sound like much, but it is the difference between going broke at 91 as opposed to 98.

In truth, both accounts (with a little management) should last longer than those simplified calculations: if you are getting dividends from a dividend aristocrat (a company with a reliable history of increasing dividend payments over time), your returns will increase year over year along with inflation. The Roth advantage accelerates in this case: with the Roth you would still have $941,000 in principal if you lived to a hundred; adding that principal you your distributions would equal nearly $3-million. The Traditional account—due to the need to withdraw substantially more to cover taxes—would run out of money at 93 years age, with $1,358,903 worth of total distributions. This is a $1.6-million difference in returns (you, of course, would have to live to 100 to realize the full amount; but you would also leave quite a bit more in your estate for family and charity).


IRA Limitations

There are a couple of caveats to IRAs: strict income limits restrict who can invest in these funds; as well as annual contribution limitations. The total that you can contribute annually to all IRAs is $6,000 ($12,000—$6,000 for each spouse—if you file jointly). Note that there are a variety of income restrictions related to marital status, whether you or your spouse are covered by a plan at work, and if you are married whether you file jointly or not. Click here for a more detailed description on Traditional IRA limits. Roth IRAs have similar restrictions, but a bit more simplified. Click here for details on Roth IRA limits.

For the reasons listed in the previous section I would generally suggest investing in Roth IRAs. The mathematical truth of the matter is that—as long as you reinvest all your tax savings from a Traditional IRA—the differences between a Roth and a Traditional IRA shrink dramatically. Still, the Roth will be worth more over the long-term due to its perpetual tax-free status with no required minimum distributions. And I find that most people do not invest the taxes that are saved on a Traditional IRAs: either they are investing the full $6,000 allowed by rule anyway (i.e. they cannot invest the tax savings into an IRA), or they are not differentiating their taxes to the degree that they can discriminate between the different sources of their tax return.

Mathematically, the amount that you end up with in a Traditional IRA (minus taxes) will be the same as the amount that you end up with in a tax-free Roth IRA (assuming equal rates of return)—so long as you reinvest the tax gains from the Traditional contribution immediately. In reality, there is almost always a delay between contributions to a Traditional IRA and the tax returns from the deduction; this means that earnings on the tax portion will lag a bit, resulting in a slightly lower rate of total return.

The only truly compelling reason to contribute to a Traditional IRA is if you have reason to suspect that your earnings in retirement will be substantially lower than they are while you are investing (i.e. you are making much more in a particular year than you will make in retirement). For individuals who are close to retirement, it is possible to have a high degree of confidence that your tax rate will decline (due to a decline in income) in retirement: this is when a Traditional IRA comes into its own, although the longer that you will be using the funds in retirement, the more likely that the advantages of a Roth will overcome the tax benefits.

And there is this also: as I write this on the backside of Coronavirus, 2020, there are two compelling reasons to believe that current tax rates will inevitably increase for the majority of tax-payers: the tax rate is currently very low (from a historic perspective); and national deficits are incredibly high (cutting deficits will require both spending cuts and tax increases). There is an asymmetric risk of higher taxes in the years to come at most income levels. Roth accounts create additional protection for this risk.

If you have any questions feel free to contact me. Stay safe out there.



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Kill Your Credit Card

The first step along the road to financial independence is to get rid of high interest rate debt. I am staring at you, credit card. By all means put everything that you can on that points-earning Visa, but pay it in full every month. A 1.5% a month is a stupid loan that otherwise smart people get themselves into. There is absolutely no sustainable investment that pays 18% per year. If you are carrying credit card debt, the best investment that you can make is to pay it off before you begin investing.

The second step on the path to a quality-of-life retirement is wrapped up in a little business term: positive cash flow. Simply speaking, that means making more money than you spend. The only way to build up savings is to not spend as much as you make. Obvious, I know, but worth mentioning given the statistics on the overall paucity of savings in the United States.

“Warren Buffett was asked by a friend who had just come into money: ‘Where should I invest?’ The Oracle of Omaha replied: ‘Pay your credit card off. I cannot get an investment to return anything near the 18% per month that you are currently paying in interest.'”


The Path to Financial Security

Whenever possible, you want your money make money. There is nothing better than to deploy your savings so that it makes money while you are asleep. Or on vacation. Watching a movie. Mowing the yard. Teaching your kid the ABCs. Name it, there is nothing sweeter than letting interest, dividends, and capital gains do your work for you.

The path to financial security is perpetually damned by a little thing that physicists call entropy: no matter how hard you try to create a perfect mechanism, chaos has a way of creeping in. Taxes, risk, business cycle, coronavirus, financial meltdown, war, political strife, pretty much anything that you see on the news has the possibility to destroy your nest-egg.

The bad news is that—in the real world—there is no way for your money to make money without effort on your part. Even passive investors need to tune in from time to time. Decisions that you make now have the potential to radically alter your financial condition a decade or so down the road.

As far as savings goes, just about the worst thing you can do is leave it in a cash account long-term. Checking and savings accounts are best thought of as devices to provide for necessary short-term liquidity: they ensure that your bills get paid, that you can put gas in the tank, and that all the normal little things that you spend money on day-to-day gets covered. Once positive cash flow begins to result in balances that are not needed to cover daily and monthly expenses, the first thing to do is to figure out how to make interest on the stagnant money.

In pretty much every business on the planet, one way to increase profitability is to reduce latency: the longer something sits on a shelf, the longer it is at risk of being stolen, or damaged, or lost, and the more that you have to spend in rent and insurance and interest rates to maintain it until it is sold. It is doing you no good until you can turn it into revenue. The money that is sitting in your bank account is no different. For each day that it is not making money, it is losing purchasing power.

Lies, Damned Lies, and Inflation

Time is a double edged sword: spend it well, and you will fund accomplishment. Yet every second that passes is another second closer to death. It is relentless, unstopping, precious, and inescapable. It provides opportunity, but also degrades everything over time. Bury a dollar in the sand, and when you dig it up it will be worth ninety-five cents.

With few exceptions, the cash in your savings account is costing you better than 2% per year. Throughout modern history, a dollar saved is worth less than ninety-seven cents after a year. You are paying interest on your cash, at a  historical average of a bit over 3% . That means that every couple decades your cash savings will buy you half the stuff that it originally would have.

The first goal for savings is to ensure that your cash will—at the very least—buy you as much in the future as it would buy you right now. You want to keep up with inflation, at the very least.

Fortunately this is not supremely difficult, nor does it involve very much risk. All you have to do is to get your excess cash into a mix of investment grade and government bonds or ETFs. The potential to lose capital on such investments is very small; the potential to lose capital to inflation on uninvested cash is all but certain.

Savings Tranches

There is no hard and fast on how to allocate your savings, but there is general consensus that you should have several different layers of exposure to volatility and capital risk. The money that you need for month-to-month cash flow purposes should be held as cash: as long as it is not “sitting on the shelf” for more than a few weeks, you are fine. There is no such thing as a perfectly efficient financial system, so a little dead loss from holding enough cash in order to avoid an embarrassing situation (say, your card getting denied on a lunch date) is perfectly fine.

After that is savings for a rainy day: in case your car suddenly needs significant maintenance; or you suddenly need to cover a 1% deductible for hail damage to your roof. Or if you lose your job unexpectedly and need to float bills for a few months. A savings rule of thumb is six months of basic living expenses.

The thing about this tranche of savings is the requirement for it to be reliable. One of the more likely times to lose your job is during a downturn in the market, so holding these funds in volatile stocks is not a good idea: you do not want to take a 30% capital gains loss the moment that you need your savings the most. A healthy mix of high grade bonds and consumer staples stocks assures returns that will keep you ahead of inflation, while significantly reducing the risk of capital loss during adverse market events.

The third tranche is the long-term horizon. It is the money that you are saving for retirement. Depending on your age, this horizon can be anywhere from a few years to several decades. Success in investing this money is going to be measured over a long period—the longer the period, the less concerned you are with short-term swings in underlying value.


No sane person wants volatility: on good days you have that looming feeling that things are not going to stay good, and on bad days all you can see is hard earned money evaporating. For someone close to retirement, volatility can be devastating. For someone who has decades, it is still unpleasant.

For these reasons, investors will not put their money in volatile investments unless there is an expectation of higher returns. There is no guarantee—particularly on a stock by stock basis—that volatile investments will outperform non-volatile ones, but broadly speaking, over time, the willingness to own a diversified group of investments with higher volatility, generally results in greater returns.

Tranche Investing

Diversity is the great, universal theme of effective investing. Any one investment can go bad, and if you have everything that you own in a single investment, if it goes bad you are going to be devastated. If you have five percent in twenty different things and one of them goes south, you will have a bad day. If you have a hundred and one goes bad, you will shrug.

Diversity does not only apply to how many different stocks or bonds that you own, but also how much risk and volatility your money is exposed to. Some portion of a long-term investment should be in higher volatility-high return stuff. Rainy-day savings ought to be stable. But all of it needs to be—long term—making money. Holding cash should be viewed as a short-term strategy (you do not necessarily need to rush from one investment to another, and if the market is in decline waiting a bit can be called for; just do not let it sit there indefinitely). At the very least, get into some short-term debt.

Where is the best place to put your investment? A brokerage, or an IRA? An IRA or a 401K? What about a  529 educational savings account ? Click here to learn more about the different options for your savings, and which one is right for your particular circumstance.

Feel free to click the button below and shoot me an email if you have any questions that I have not answered here.



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“There is no greater goal for a person than to aspire to know more about the world around them. There is no better hope for a parent than that their children should be presented with the opportunity of meaning and success.”

The Great Promise of Education

It is a noble endeavor to understand new things, to search out knowledge, to expand your horizons in the search for truth. It is also a very practical pursuit, in that knowledge has proven time and again to produce returns both in economic and in personal terms. Understanding the world is the first great step to both social responsibility, and economic prosperity.

College has gotten expensive. You know that by now. It is not getting any cheaper. Like taxes and death, rising costs of education have become one of those horribly reliable certainties. Still, not all is lost. Astute financial planning allows you to substantially reduce the direct cost of education for both yourself and your family. 

See the article and video below in order to better understand the various educational savings vehicles, so that you can be effective in your savings approach to the cost of college.


The 529 Plan

If you are putting aside money for college (either for yourself or a family member) there are savings options that produce tax advantages. 529 plans are organized by individual states for the specific purpose of encouraging educational savings. In the United States, though 529 plans are organized by individual states, the federal government recognizes the savings and offers tax advantages to distributions from those accounts. And while 529 plans are the best educational savings option for many people, some individuals will be better served by other savings options.

A recurring theme with investment options is that there is generally no universal “good” or “bad” investment plan. There are rather a number of different options that produce different levels of risk, return, and tax implications. Some produce more reliable returns, but involve higher costs to maintain. Some are highly volatile, but have the potential to outperform. The question is not whether something is “good” or “bad,” but whether it is more or less efficient at helping you to achieve your particular goals.

529 Plans are State plans with Federal Benefits

The first complexity with 529 plans is that they are not directly related to the federal government. Each state has the option of establishing and regulating its own plan. The federal government has a few basic requirements for the state plans that allow for federal tax benefits. Adding a layer of opaqueness is the fact that many states provide several different types of plans (a quick search yielded me 111 different state offered 529 plans).

You are not required to select a 529 plan from your resident state, and (in general) the money from any 529 plan can be distributed for expenses at any accredited college (be sure to verify this applies to the specific plan that you are interested in).

Although you could, say, live in Colorado and invest in a Texas 529 plan, in many instances it makes sense to invest in a 529 plan in the state that you pay taxes in. Different states have different rules as it relates to the tax exempt status of contributions to 529 plans. With at least 111 different 529 options, sticking to those options from your particular state has the advantage of narrowing down the list. If you dislike the specifics of the plan offered by your state (or if your state does not offer a plan at all) you are generally free to invest in other states plans.

529 plans are largely similar to 401Ks, though (in general) a bit more restrictive: the plans offer a limited set of index/mutual funds to choose from. This provides built-in protections to the 529 architecture that benefit inexperienced or passive investors. For those who prefer a hands on approach, 529 plans may prove a bit stuffy.

College Pre-Paid Tuition

Colleges themselves may offer 529 plans which allow for the pre-payment of tuition. In some cases this means that you can lock in current tuition rates for future expenses. Given the significant increase in educational expenses over time, this can be appealing. In some cases these plans allow for the money to be applied to another college or university if your child decides to go somewhere else (in this instance, the tuition rate would not be locked in).

A couple things need to be mentioned about these plans: they are obviously designed to encourage enrollment at a particular university, and they do not guarantee acceptance at the campus—your kids still have to meet the admissions standards in order to be accepted. And while paying tuition at current rates has a nice feel to it, there are risks associated with this as well: educational expenses have averaged 8% inflation per year, around the same as the S&P 500 averages in capital gains. This means that in investment in a 529 plan will have a good shot at growing at the rate that tuition increases. 529 plans, by not being locked into a particular college, provide flexibility that pre-paid tuition does not.

Tax Implications

For most people the current long-term capital gains rate stands at 15% (if you are in the vast majority, making between $40,001 and $441,500; below this long term capitals gains is tax free, above it is 20%). If you had the foresight (and ability) to invest $10,000 in your kids account at the time of their birth, at a modest 8% per year rate of return you would have $40,000 in the account by the time they were ready for college. The first $10,000 has already been taxed by the federal government (contributions to 529 plans are after tax), while the $30,000 in gains has not.

If the investment was outside of a 529 plan, you would have to pay a minimum of $4,500 in capital gains taxes (I will be using the 15% rate for simplicity). Each state taxes capital gains differently (California adds up to 18% on top of federal capital gains rate; Texas, does not tax capital gains). So, if you live in California (and are in the top tax bracket) you would have to pony up ten grand in taxes outside of a tax free savings plan. Ouch.

And while the federal government does not allow tax deductions on contributions to 529 plans, some states allow both: tax free money going in and coming out.

Some quick math makes the advantages of these plans concrete. We already noted that an 8% return would result in $30,000 worth of earnings on top of the original $10,000 in principle. Depending on the state that you live in, you will save between $4,500 and $10,000 on capital gains due to tax free distributions from a 529 account if you invested 10,000 for 18 years at 8%.

529 Restrictions

There is no such thing as a free lunch. The 529 money comes with some caveats that create penalties in the event that the funds are not used for the stated purpose of education. If – for whatever reason – the money is not needed for educational purposes, 529 participants would be subject to a 10% federal withdrawal and income taxes on the gains (in our example, $30,000). California adds another 2.5% to the penalty. Other states vary, and if you received state tax deductions on contributions count on having to pay those deductions back.

It should also be noted that there are a number of exceptions which eliminate the penalty:

• A beneficiary dies or becomes disabled

• A beneficiary receives a tax-free scholarship

• A beneficiary receives educational assistance through a qualifying employer program

• A beneficiary attends a U.S. Military Academy

• The qualified education expenses were used to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC)

And if the beneficiary of the 529 plan does not qualify for one of the above exemptions, rules allow for a change in beneficiaries without penalty. The new beneficiary can be ANY family member: another child, cousin, grandparent, parent, aunt, stepfather—anyone that you are related by blood, adoption, or marriage to .

IRAs for education

How old will you be when your children are entering college? If you are (or will be close to) 59 ½ years old—as long as you are opening the account more than 5-years from when you will need access to the funds—open an IRA. It is really that simple.

IRAs allow penalty free distributions for money held in an IRA account for at least five years, once you have turned 59 ½. You can use that money for anything, including an education fund. So the penalties associated with a 529 if your kids decide not to go to college are irrelevant. Added to this advantage are the normal advantages that IRA’s have over pretty much every other type of savings plan.

Even if you are going to be younger than 59 ½ when the funds are needed, IRAs can still be the better option: education expenses are one of several exemptions to early withdrawal penalties (i.e. there is no 10% penalty for early withdrawals from IRAs for qualifying educational expenses). Depending on the type of IRA (Roth or Traditional) there may be some tax implications, but in many instances the IRA world offers superior flexibility when compared to 529 plans. Click here for expanded information on Traditional and Roth IRAs, including how they can be used as education savings plans.

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