6 Things to Consider Before Opening A 529 Plan
Paying for college is perhaps a more formidable challenge today than ever. Over the last five years, tuition prices at public four-year colleges have risen by 27 percent above overall inflation, according to a recent College Board survey.
Section 529 plans — special tax-advantaged vehicles designed to aid college savings — are one option for tackling these growing costs. Still, these plans may not be right for every situation. Here are six key considerations that can determine whether a 529 plan is right for you and your family.
1. Time till college
Earnings on 529 plans are not subject to taxes. However, unlike a traditional IRA or 401(k), contributions to these plans are not tax-deductible. This means that there is no immediate tax advantage to starting a 529 plan, but the tax advantage will increase over time as earnings accumulate. Thus, the longer time there is until you expect to draw from the plan, the more that tax advantage is worth.
2. Likelihood of pursuing postsecondary education
The earlier you start saving, the easier it will be to pay for college. However, it’s difficult to predict what educational needs a small child will have 10 or 15 years down the road. You should only start a 529 plan if there is a strong likelihood of your child pursuing postsecondary education. However, a wide variety of educational options are covered by 529 plans, including vocational schools, so there is a pretty strong chance your child could benefit from some education beyond high school.
3. Estimated cost of education
To avoid being penalized, you do not want to have money left over in the 529 plan when the beneficiary’s education is completed. So, the more you expect to have to pay for college or vocational school, the more comfortable you can feel with contributing to a 529 plan.
4. Family size
While 529 plans must be set up for a specific beneficiary, there is some flexibility in allowing that money to be transferred without penalty from one beneficiary’s 529 plan to another. If you have multiple children, it should reduce the risk of having money left over in a plan, because if that happens, you can just roll that money over to the next child in line.
5. Plan fees
While some 529 plans are offered by states, you are not limited to choosing the plan offered by your state. So be aware that there are competitive alternatives, and fees should be one of the foremost considerations in deciding on one of these plans. If the fees exceed the likely tax benefits, it isn’t worth investing in that 529 plan.
6. Investment approach
Again, the tax benefit is derived from how much the plan earns. Given the low level of savings and money market rates these days, you may not get much tax benefit if you plan to invest very conservatively, but more aggressive, long-term investment approaches could benefit significantly from the tax treatment.
One goal with a 529 plan should be to avoid putting more in than the beneficiary is likely to need. For this reason, it may be wise to make a 529 plan the foundation for college financing, but not the way you fund the entire expense. Not only will this reduce the chance that you will be left with unused money in a 529 plan, but it will also allow you to use a 529 plan as an allocation to more aggressive investments that could benefit most from the tax exemption on earnings.
Frequently Asked Questions
Q: What is the best way to save and grow money for my son’s college tuition?
A: Paying for college is a significant financial task, and increasingly students are leaving school with difficult debt burdens. According to the College Board, the average annual public college tuition for in-state four-year degree students is $9,410. For private colleges that annual figure jumps to $32,410. Expect these figures to be even higher by the time your son reaches college.
Those numbers make for some lofty targets to shoot for, so the earlier you start saving for a child’s education, the more you are likely to come close to the target and reduce the debt burden your child has upon graduation. The following are a few things you should know about saving for college.
Section 529 college savings plans
Section 529 college savings plans are offered by states and by individual educational institutions. Contributions to these plans are not tax deductible, but any subsequent investment earnings are free from taxes as long as they are ultimately spent on legitimate educational expenses.
One nice feature of 529 college savings plans is that balances can be transferred to a new beneficiary if the original beneficiary does not spend all the money in the plan. This gives you some flexibility so that even if you over-save for the first beneficiary, you have others in mind who can put the money to good use. However, if you only foresee one beneficiary being able to use these savings, it is better not to put more money in the account than you are likely to use.
Note that since the tax benefit of 529 savings plans applies only to investment earnings in them, they have the most potential benefit if you set them up many years before the student reaches college, so they can shield several years worth of earnings from taxes. The benefit of these plans is sharply reduced if the student is only a year or two from college.
If you are looking for growth, long-term investments like stocks are the most appropriate. These are also risky, but you can dampen the risk somewhat by broadly diversifying your portfolio.
Because stocks are volatile, you should shift into more stable investments as your child approaches college age, eventually investing in fully liquid vehicles like savings accounts or money market accounts as the time for drawing money out of the account draws near.
You can sharply reduce your son’s college expenses by making full use of the financial aid available to him. As he nears college aid, check out the federal financial aid application site at www.fafsa.com. When he starts considering particular schools, ask their financial aid offices about what assistance might be available.
One side benefit of working through all this – from early saving to managing the money to researching financial aid – is that it can be a learning experience for your son so he gains some important financial knowledge even before attending college.