How to Save for College and Start a 529 Plan

Parents of college-bound students know that the costs of college has risen dramatically. The College Board, the creator of the SAT, conducts a survey of average college pricing from universities across the country. For the 2013-14 academic year, the average cost for an in-state public college is $22,826, while the average private college is $44,750. These costs include tuition, room and board, fees, books, and an allowance for personal expenses.

Of course, financial aid might help cover some of these costs, along with scholarships, but the overall expected expense is a good
starting point to begin saving for college. For parents who want to see how much college will cost when their children graduate from high school, we recommend the College Cost Calculator. Assuming an 8 year old child, the results indicate total college costs of $175,000, but parents can also tweak the report by calculating how much of the costs they will cover, how much they currently have saved,  and what rate of return they expect. For parents who expect to cover 75% of the costs and already have $5,000 saved, the suggested monthly savings is $562 for the next ten years.

What is a 529 Plan

So now you know that you need to save for college, but how? The most popular form for college savings is a 529 plan. The SEC defines 529 plans as “a tax-advantaged savings plan designed to encourage saving for future college costs.”  Other options include Coverdell Education Savings Accounts, custodial accounts, trust funds, savings bonds, and simply savings accounts at local banks. One of the most important benefits of a 529 plan is that it is considered an asset to the parent (or person who contributes, such as grandparents) and therefore, do not count against the student for financial aid.

The two distinct types of 529 plans are the prepaid/tuition guaranteed plans and the college savings plans. The prepaid/tuition guaranteed plans are usually offered by the state and promise to “lock in” the costs of college so that parents can save towards that fixed amount. Unfortunately, many states have managed these plans poorly, are breaking promises to parents and investors, or no longer functioning at all.

Parents have the option of investing in a 529 plan directly or using a financial adviser to manage the process and accounts. While you will incur lower expenses with a direct-sold 529 plan, utilizing the services of a capable financial professional may be worth the added expenses since he will be more capable of matching the right 529 plan to your particular investment goals and risk preferences. Experienced financial aid professionals will also be able to help coordinate your college planning with other long-term objectives, such as retirement and estate taxes.

Advantages of a 529 plan

• Your investment grows tax-deferred
• Distributions to pay for college expenses are generally federally tax-free
• Some states offer tax breaks as well
• The donor (and not the stated beneficiary) retains control of the funds
• Donors may reclaim the investment, no questions asked (although subject to tax if not used for college expenses)
• Low maintenance- once you select a 529 plan and start contributions, it doesn’t need ongoing management
• Flexible enough to allow rollovers to different plans
• Plans can be rolled over to siblings of the initial beneficiary, which is very useful in circumstances where the oldest child chooses not to go to college or gets a large scholarship
• 529 plans are considered a parent access so assessed at a much lower rate than student’s access for federal financial aid
• Anyone may open an account on behalf of a beneficiary, and anyone can contribute
• 529 funds can be used nationwide, public or private college, trade school or graduate school
• 529 funds also cover many “qualified expenses” including tuition, fees, supplies, on-campus room and board, and even certain expenses for special needs students
• Low minimum contribution and no income limitations

Disadvantages of a 529 Plan

• If you don’t use the funds for college (or qualified educational expenses) you will pay a large penalty: 10% fee plus federal income taxes on the earnings
• 529 plans are vulnerable to stock market fluctuations, like all savings plans that invest in the stock market
• Some brokers charge large fees, that may eat up your first year earnings.

How to chose a 529 plan

Choosing which plan and where to put your money can be daunting and overwhelming.  Evaluate your options by:

1. Analyze the investment returns.

2. Find out who runs the plan. You’re looking for a group with a solid positive track record and a strong lineup of funds. You can get more information on individual funds from Morningstar, an independent research firm. (Check out your state-based 529 options here.)

3. Read the fine print for penalties, fees and restrictions. Some plans will have age restrictions, others have penalties for large withdrawals in the first few years. Check for annual maintenance fees and sales commission.

If those three steps seem too complicated or you don’t have time to research all of the options yourself, consider a broker. Many banks offer 529 plans as well, such as Bank of America, Wells Fargo, and Chase.

Regardless of how you chose to start saving for college, the earlier you start, the easier it will be to accumulate the amount you and your children need.

For more information about section 529 plans and other education tax benefits, please see Comprehensive Guide to 529 Plans or the  IRS Publication 970, Tax Benefits for Higher Education.