Like saving for retirement, you can never start too early on saving for college. The cost of post-secondary education continues to outpace inflation. According to FinAid.org, the historical average college tuition inflation rate was 8%, compared with 3.2% for inflation. More recently, tuition inflation rates have been hovering around 6% annually and inflation overall is a little over 2%.
College will cost how much?
According to CNBC, Fidelity has a new “$2K” rule of thumb: If you intend to cover half the cost of college tuition at a four-year public university, multiply your child’s age by $2,000. For example, a 10-year-old should have a 529 savings plan account with $20,000 in it. Obviously, if you intend to send your child to a more expensive school or cover more than half the cost, the target amount should be higher.
The College Board’s 2016 study “Trends in College Pricing” indicates the average cost of four-year public in-state college hit $17,100 for the 2016-17 school year. That figure includes undergraduate tuition, room and board. The cost for private school undergrads? An average of $43,440. By 2024, those averages are expected to climb to $34,000 and $76,000, respectively.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The Struggle
Many of my clients ask a similar question: How should our savings be directed? When there are several competing priorities – emergency fund, paying off debt, saving for retirement, etc. – adding education savings to the list may seem too daunting. Generally, I encourage young families to focus on immediate goals like the emergency fund and debt management. We also look at maximizing any employer match through a company-sponsored retirement plan. THEN, and only THEN, do we explore 529 plan funding.
Two Types of 529 Plans
In the world of 529 college savings plans, there are two primary types: Prepaid and Savings.
Prepaid plans are available only in select states and allow you to purchase tuition credits at today’s rates. Since these prepaid plans are administered by the state or higher education institution, investment performance is tied to tuition inflation.
The more common 529 college savings plans are available nationwide and are subdivided into broker and direct plans. Broker-sold plans can be purchased through an investment adviser and are professionally managed by that adviser. Direct plans, on the other hand, are generally less expensive but more of the “DIY” version. You, as the account owner, decide how to allocate investments in direct plans. Many of these state-run savings plans offer age-based options that gradually become more conservative as the beneficiary nears college age. The market performance of any 529 savings plan is tied to the underlying investment.
Debunking the Myths: Take the Quiz
Now that you understand the types of 529 plans, let’s play a game: TRUE or FALSE.
1. True or false: You must invest in the 529 plan of your home state.
FALSE. Several states offer a state income tax deduction only if you invest in your home state plan, but other states provide tax parity whereby you receive the state income tax deduction even if you contribute to an outside state’s plan. Examples of these parity states include Arizona, Kansas, Missouri and Pennsylvania.
2. True or false: You will lose money if your child (the beneficiary) doesn’t go to college.
FALSE. The amount you initially contribute to a 529 plan can be withdrawn without penalty. Only the “gain” or appreciation is subject to income tax and 10% penalty for non-qualified (“NQ”) distributions. Let’s suppose you contributed $50,000 to a 529 plan and the balance grew to $60,000. You pay income tax and 10% penalty on the $10,000 gain of NQ distributions. Furthermore, if your son or daughter will not be attending college, you can transfer 529 funds to another family member without penalty. There is no age or income limit for a beneficiary.
3. True or false: A 529 plan allows you to save for future higher-education costs and simultaneously make a tax-advantaged investment.
TRUE. Contributions to 529 plans grow tax-deferred, and qualified distributions are tax-free. By definition, qualified 529 plan withdrawals include tuition, fees, books, equipment and supplies. Room and board is also considered “qualified” if the student is enrolled at least half-time at a university or vocational school.
4. True or false: Many 529 plans allow out-of-state investors, but other benefits may apply to investors who participate in their state-sponsored plans.
TRUE. Choosing your home state plan may result in matching grants and scholarships, protection from creditors and exemption from state financial aid calculations. If you reside in a parity state, lower fees and superior historical investment performance may entice you to choose an out-of-state plan. Regardless of which state plan you choose, there is a downside: 529 plan balances impact the federal student aid calculation for need-based aid and reduce eligibility for select federal tax credits. Assets in accounts owned by a dependent student or one of their parents are considered parental assets on the FAFSA. When a school calculates the student's Expected Family Contribution (EFC), only a maximum of 5.64% of parental assets are counted. This is quite favorable compared to other student assets, which are counted at 20%. Higher EFC means less financial aid.
I personally believe the benefits of 529 plans outweigh any disadvantages. Interested in establishing a 529 plan? The website SavingforCollege.com offers additional resources.
-
$177 Million AT&T Settlement Announced — Are You Eligible for a Payout?Millions of current and former AT&T customers may be eligible for payments after two 2024 data breaches exposed personal information.
-
Social Security Turns 90 — Five Important Things to KnowSocial Security has become a cornerstone of the American retirement system and works to keep over 16 million retirees above the poverty line. Here are five key facts about the program as it turns 90.
-
Asset-Rich But Cash-Poor? A Wealth Adviser's Guide to Helping Solve the Liquidity Crunch for Affluent FamiliesMany high-net-worth families experience financial stress because of a lack of immediate access to their assets. Liquidity planning aims to bridge the gap between long-term goals and short-term needs and avoid financial pitfalls.
-
Social Security Planning Strategies and Challenges as It Hits Its 90th Year: A Financial Adviser's GuideLonger life expectancies and changing demographics put extra pressure on the program, making it crucial for future retirees to understand its evolution, common myths and how to strategically plan for their benefits.
-
How to Build Your Financial Legacy Three Piggy Banks at a TimeA wealth adviser shares a childhood saving technique that taught him lessons of stewardship, generosity and responsibility and helped him answer the question we all need to answer to define our lives by impact rather than greed: 'What is this all for?'
-
Which of These Four Withdrawal Strategies Is Right for You?Your retirement savings may need to last 30 years or more, so don't pick a withdrawal strategy without considering all the options. Here are four to explore.
-
DST Exit Strategies: An Expert Guide to What Happens When the Trust SellsUnderstanding the endgame: How Delaware statutory trust dispositions work, what investors can expect and why the exit is probably more important than the entrance.
-
Think Selling Your Home 'As Is' Means You'll Have No Worries? Think AgainThere are significant risks and legal obligations involved in selling a home 'as is' and by yourself, without a real estate agent.
-
What the OBBB Means for Social Security Taxes and Your Retirement: A Wealth Adviser's GuideFor Americans in lower- and middle-income tax brackets, the enhanced deduction for older people reduces taxable income, shielding most of their Social Security benefits from being taxed.
-
Financial Planner vs Investment Manager: Who's the Better Value for You?When markets are shaky, who do you trust with your money? A recent study provides useful insights into the value that different financial professionals offer.
