529 Plans and How to Save for Your Child’s College Education

by Sophia Bera on May 10, 2017

At Gen Y Planning, we work with a lot of clients that are thinking about having kids in the next few years, or already have young children. As you can imagine, I get asked about saving for college a lot.

With the cost of college going up about 5% a year, today’s newborns can expect their bachelor’s degree to cost nearly half a million dollars if they go to a private school, and nearly $200,000 for a public school. And that doesn’t include the $250,000 it costs to raise a child through the age of 18.

That’s a lot of money. Hopefully, college costs won’t consider to rise at that rate and college will likely look very different 20 years from how. However, the sooner you can get started saving for college, the better you can prepare for the costs.

Many clients ask me about the best way to save for college. While there is no “one size fits all” answer, I usually suggest 529 Plans as a great way to get started.

But First, Take Care of Yourself

Sometimes people become obsessed with putting money into 529 Plans without taking time to build a solid financial foundation for themselves. This is especially important because while you can borrow money to pay for tuition, you can’t borrow money to fund your retirement.

Remember: you aren’t doing your kids any favors if you drain your savings to send them to that private liberal arts college, but you need to rely on them to support you financially in retirement. The best gift you can give your children is being financial stable in retirement.

So before you fund a 529 Plan, ask yourself a few questions:

  • Are you still paying off your own student loans?
  • Do you have any high-interest credit card debt?
  • Do you have adequate emergency savings? (Aim for 3-6 months of net pay.)
  • Are you contributing enough to retirement accounts? (Contribute enough to get a 401(k) match from your employer, max out a Roth IRA, and then set a goal of increasing your 401(k) contributions even more.)

You might have more pressing financial concerns to deal with right now. Once those are under control, you can begin setting money aside for your child’s education.

What is a 529 Plan?

A 529 Plan is a state-sponsored education savings plan that offers several tax advantages.

  1. Some states allow you to deduct your contributions on your state taxes.
  2. Your contributions grow tax-free in the account.
  3. The balance can be withdrawn tax-free for qualified educational expenses (tuition, room and board, fees, books, and computers).

WARNING: you’ll be hit with a 10% penalty plus pay income taxes on any withdrawals to the account for non-qualified expenses.

However, there are ways to avoid this. If the original beneficiary of the account doesn’t end up using the money, you can change the beneficiary to another family member with no penalty or tax consequences.

While 529 Plans are offered by each state and the District of Columbia, you don’t have to pick the plan offered by your state of residence. If you live in a state that doesn’t offer a state tax deduction for your contributions, you can pick a different state’s 529 Plan.

I often recommend NY Saves 529 Plan because it offers low-fee Vanguard funds and I like the way they’ve allocated the portfolios in the age-based options. You can research different 529 Plans available at savingforcollege.com.

What About Pre-Paid Tuition Plans?

Pre-paid tuition plans are a type of 529 Plan account where you lock in the cost of today’s tuition for a child who will be attending college in the future. I’m actually not a fan of these plans because the money in these accounts can’t be used at any school. If your child isn’t going to stay in-state, the plan won’t pay the full amount of tuition. You also have to be a resident of the state providing the plan.

Watch Out for High Fees

529 Plans are investment accounts and you can change your investment options once a year or whenever you change your beneficiary. Look for investment options with low expense ratios and be cautious about investing the money too aggressively. You’ll need to access this money in a much shorter time horizon than retirement so it’s important that you’re monitoring the accounts so that the money is moved to less risky investments as your child approaches college age.

Start Small, Save Big

If you start a 529 Plan when your baby is born with $1,000 and you set aside $100 a month until they turn 18-years-old, your child could have over $40,000 set aside by the time he or she turns 18 (assuming a 6% rate of return). Many of the 529 Plans allow you to set up a monthly contribution as small as $25 a month. A small investment could make a big difference when it comes to paying for college.

 

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