Contributing $1,000 to a state-sponsored college-savings plan is a great way to take a bite out of future college costs. Stash that much today in a newborn's account earning a return of 8%, on average, and it will be worth nearly $4,000 by the time he or she is ready to start college. But why stop there when you can follow the lead of Michael and Eileen DiChiacchio of Springfield, Pa.? They are nibbling away at tomorrow's college costs for their two children one paycheck at a time.
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The DiChiacchios started saving for college eight years ago, when their son, Brandon, was born. At the time, Pennsylvania didn't offer a tax deduction for contributions to its 529 plan, so they looked beyond the borders of the Keystone State and chose New Hampshire's 529 plan for its broad range of investment choices from Fidelity and its relatively low fees. They started by sending $50 a month to an account for Brandon and one for his sister, Morgan, 10, and gradually increased their monthly contribution to $300, split evenly between the two accounts.
They've accumulated more than $20,000 in total college savings so far. At their current contribution rate, Morgan will have about $40,000 when she starts college in eight years, assuming an 8% return. "I'm not sure it will be enough, but it's a start," says Michael, a project manager for a real estate investment company.
Just last year, Pennsylvania instituted a tax break for 529-plan contributions -- one of the most generous in the nation -- allowing resident contributors to deduct up to $12,000 a year per child. It is one of only three states that allow resident participants to deduct their contributions to any state-sponsored 529 plan. (Kansas and Maine started similar tax breaks this year, but with much lower deduction limits.) With a 3.07% state income-tax rate, each $1,000 the DiChiacchios invest reduces their state income-tax bill by $30.70.
When choosing a 529 plan, first consider whether your state offers a tax deduction for contributions to its own plan, as 28 states and the District of Columbia do. If it does, that deduction may outweigh the benefits offered by other states with better investment choices. If it doesn't, consider all the plans that do not limit their 529 plans to state residents. (We like Iowa's low-cost Vanguard funds.) See more of our favorite plans and get the details on your own picks with this 529 tool.
While there is no federal-income-tax deduction for 529-plan contributions, earnings grow tax-deferred and withdrawals are tax-free if used for qualified educational expenses. For details, go to www.savingforcollege.com.