Most parents want their children to go to college. That diploma will be their passport to better job opportunities and higher paychecks for the rest of their lives. As we are frighteningly aware, though, college costs are high and constantly increasing. Even in-state public school tuition averages $9,400 a year. If you have the dream of sending your child to a private college, you may be paying $32,000 a year or more!
Hopefully you’re already saving money for college. But if you’re just putting the money in the bank, you’re not growing it the way you could be. By investing college savings in a 529 plan, you can earn dividends tax-free.
Advantages of a 529 plan
Each state offers a 529 plan, and the rules may be slightly different from state to state. However, they all allow you to save and invest college funds while your child grows. A 529 can grow 4-5% annually–much more than you’d get by putting the same money in a savings account. As long as the money is spent on your child’s education, you pay no tax on the earnings.
The 529 plan will name your child as the beneficiary; however, you can transfer the balance to someone else. So if you fund a plan in your eldest child’s name, and that child chooses not to go to college, you can transfer the balance to your next child without a penalty. You can even transfer the plan to a niece or nephew.
A child can also have 529 plans managed by grandparents, aunts, uncles, or anyone else who wants to contribute to their education. Or you can tell loved ones they may donate to yours, as a gift to your child.
Money you withdraw from the plan can be spent on tuition, fees, textbooks, or even room and board. However, if you withdraw the money for any other purpose, you’ll be hit with a 10% penalty. That money is dedicated to educational expenses, not a handy fund for other needs.
Types of 529 Plans
529 plans come in a few different types. Here’s a brief summary of each kind so you can choose the one that fits best for you and your child.
Prepaid tuition plan
The first option isn’t exactly a fund at all. Instead, with a prepaid tuition plan, you pay the cost of in-state public tuition now, and when your child is ready for college, you get credits equal to the cost of in-state public tuition then. So instead of investing your money, you’re saving yourself the price increase that may happen between now and when your child enters college.
Given the constant increase in college costs, this type of plan will certainly save you money. And, because you aren’t investing your money, you risk nothing; the cost of college is paid in advance. However, you will need to have enough money to pay for it already—it won’t increase the size of your fund the way a traditional 529 will.
In the age-based 529 plan, your contributions are invested aggressively when your child is young, but as the time for college approaches, the assets are gradually switched to more conservative investments, like bonds. This allows your investment to grow quickly early on, but not risk a major loss too close to enrollment.
This plan is a good option if you want your fund to manage itself, without personal involvement. It keeps you from losing much of the fund if the market takes a major downturn close to your child’s high school graduation. And, if there is a downturn early on, there will be plenty of time to make up the losses over the years.
Static 529 plan
This plan allows experienced investors to choose their own investment strategy, whether safe, aggressive, or individually managed. The asset allocation remains the same throughout the life of the plan, unless you change it.
Inexperienced investors may be tempted to tinker with it, especially in the middle of a market downturn. But, if you’re confident you know how to best invest your money, you can stick to your chosen strategy over the life of the plan and come out ahead.
You don’t have to select just one type of plan. You can put some money into an age-based plan and some into a static plan. Or, if you have other investments you can use for college, you can choose an aggressive 529 plan, knowing you have the other investments as a fallback.
When you make your decision, you might want to consider how much you can save per year, how much you would like to have in your child’s fund by the time they need it, and what other assets you have to help pay for college.
Ready to start?
You can search for 529 plans in each state at savingforcollege.com, or Google your state’s name and “529 plan.” To get advice on what kind of plan is best for you, or how to build a budget with room for college savings, you can speak with one of our financial advisors. Don’t wait—the sooner you start saving, the more you’ll have ready when your child needs it!