Advertisement
529 Plans

The Best College Savings Strategy to Use

A 529 college savings plan comes with many advantages, and the best way to harness its power is to start ASAP and front-load your contributions.

If you’re a parent, you’ve undoubtedly wondered how you should save for your kids’ college educations … and how much you need to save.

With the cost of college only continuing to rise at a clip that outpaces inflation, we can expect higher education to require a hefty amount of money in the future. The best strategy you can use to be prepared for this reality is to start saving as early as you can — and don’t get caught playing catch-up later on.

Leverage a 529 Plan for College Savings

One of the best places to stash cash earmarked for college costs is within a 529 plan. The money you contribute here can grow and be used tax-free when your kids go to school (as long as the money is spent on qualifying education expenses).

Advertisement - Article continues below

Because they’d need a Social Security number, your children need to be born before you can start using a plan; you can’t contribute before you have kids, or even while pregnant. (Note that, technically, if you’re determined to start saving before you start a family, there is one way around it: You can open account with yourself as the beneficiary, and then later switch it to your child.)

As soon as your children arrive in the world, I’d recommend setting aside a small amount of money each month into a 529 plan for them.

Advertisement
Advertisement - Article continues below

Why? Compounding! If you start when your child is born, that gives you 18 years to save. Many parents read that and feel they have plenty of time — but if you wait, you give yourself an uphill battle when it comes to saving enough.

Here’s the thing: Compounding returns is what will allow you to save less every month as long as you save longer. If you start when your child is young, it will be easier to generate the money needed to pay for college costs.

Advertisement - Article continues below

The more money you put in earlier the more time it has time to compound!

Why You Should Front-Load Your College Savings Accounts

Time is arguably your biggest advantage as an investor, because more time leads to increased compounding. Not convinced? Let’s look at a specific example with real numbers.

Imagine that three families all contribute the same amount of cash, $90,000, to their child’s 529 plan over 18 years — but they contribute the money at different times.

Family 1 (we’ll call them the Even Stevens Family) contributes $5,000 per year to a 529 plan.

Meanwhile, Family 2 (who we’ll call the Late Lees Family) contributes $1,000 per year in first five years. They gradually increase their contributions over time as college gets closer, with $2,500 per year for years 6-10, and $5,000 per year in years 11-15. In the last three years they have to save before their kid goes to college, they save $12,500, $15,000 and $20,000.

Advertisement - Article continues below

Finally, Family 3 (or the Early Easons Family) takes yet a different approach: Over the 18 years they have to save for college, they contribute $20,000 per year to the 529 plan for the first four years. In savings year five, they contribute $10,000. And then they simply leave the money invested in the plan, without contributing more cash between now and when their child goes to school.

Advertisement
Advertisement - Article continues below

Which family had the best strategy? Who ended up with the most money in the 529 plan? Here’s what each family has in their plan at the end of that 18-year savings period :

Getty Images

The results might surprise you. As we can see, the Stevens family ends up with almost $30,000 more saved for higher education expenses than the Lees — even though both families contributed the same amount of money.

This is how compounding works: Your money needs to time to grow. The Stevens family gave more of their money a longer period of time to grow. Even though the Lees made some pretty big contributions late in the game, that money never got a chance to compound — so they ended up with less overall.

Advertisement - Article continues below

And just look at what happens if you focus on saving as much as you can as early as you can! The Easons have vastly more money available to fund college — even though, again, they contributed the same amount as everyone else. But they also gave their money the most time to compound and grow, which is why they have over $81,000 more than the Lees and over $51,000 more than the Stevens family.

But What If Your Kid Doesn’t Go to College?

Of course, there’s one big caveat to all this, and it’s one some parents fear dealing with down the road: After all that effort to save “early and often,” what happens to the money in the 529 plan if your kid doesn’t go to college in 18 years?

For parents of multiple children, you could change the beneficiary of the account to another child in your household (or another family member, even yourself). And if you don’t need the money because your child gets a full scholarship, the 10% penalty for taking the cash out of the 529 plan is waived. (For more on that, read The 529 Plan Scholarship Exception.)

If this isn’t an option for whatever reason, then you might be looking at a worst-case scenario: a bunch of college savings with no college student. But this isn’t actually as bad as it seems, because you can access that money. You pay a 10% penalty on the earnings, but most families agree this potential risk is much better than not having enough savings for college for a child who does end up going.

Want to learn more? Be sure to check out this post about difference between direct and broker sold 529 plans — and why you need a direct plan.

Advertisement

About the Author

Paul V. Sydlansky, CFP

Founder, Lake Road Advisors, LLC

Paul Sydlansky, founder of Lake Road Advisors LLC, has worked in the financial services industry for over 20 years. Prior to founding Lake Road Advisors, Paul worked as relationship manager for a Registered Investment Adviser. Previously, Paul worked at Morgan Stanley in New York City for 13 years. Paul is a CERTIFIED FINANCIAL PLANNER™ and a member of the National Association of Personal Financial Advisors (NAPFA) and the XY Planning Network (XYPN). In 2018 he was named to Investopedia's Top 100 Financial Advisors list.

Advertisement

Most Popular

7 Surprisingly Valuable Assets for a Happy Retirement
happy retirement

7 Surprisingly Valuable Assets for a Happy Retirement

If you want a long and fulfilling retirement, you need more than money. Here are the most valuable retirement assets to have (besides money), and how …
August 3, 2020
Shrink Your RMDs in 2021 and Beyond
annuities

Shrink Your RMDs in 2021 and Beyond

QLACs are a special type of annuity that lets you cut RMDs from your IRAs next year and beyond, reduce the taxes you pay and guarantee more lifetime …
August 6, 2020
How a Second Stimulus Check Could Differ from Your First One
Tax Breaks

How a Second Stimulus Check Could Differ from Your First One

The HEROES Act, which was passed by the House in May, would authorize a second round of stimulus checks. While the new payments would be similar to th…
July 22, 2020

Recommended

7 Ways to Save Money When Shopping Online
Smart Buying

7 Ways to Save Money When Shopping Online

Shopping online has long been a popular option. In these times, it’s increasingly a must. Here’s how to save money when filling your cart with the cli…
August 7, 2020
6 Money-Smart Ways to Spend Your Stimulus Check
Tax Breaks

6 Money-Smart Ways to Spend Your Stimulus Check

If you don't have to use your stimulus check for basic necessities, consider putting the money to work for you. You'll thank yourself later.
July 30, 2020
College During COVID
Paying for College

College During COVID

Students and their families must be ready to adapt to the changes in the way they attend—and possibly pay for—college.
July 30, 2020
How COVID-19 Is Changing the Way Families Save for College Costs
college

How COVID-19 Is Changing the Way Families Save for College Costs

CollegeFinance.com's Kevin Walker joins our Your Money's Worth podcast to discuss how the global health pandemic is impacting the way families plan a…
July 28, 2020