May 29th (5/29) is National 529 Day and by extension May is frequently known as 529 Month, both great reminders and opportunities to save and invest for college. But remember, as May comes and goes, every month is a good time to save for college. Getting started, saving systematically (month over month), and putting time on your side are the keys to achieving your college savings goals and fulfilling your higher education dreams. Even small contributions made consistently can make a big difference over time and reduce your reliance on borrowing.
Taking Advantage of 529 Plans
Tax-advantaged 529 plans (so named after the IRS code number) are a smart way to offset increasing higher education costs. Earnings grow tax deferred and are tax-free when distributions are taken for qualified education expenses. Qualified expenses include a wide variety of college costs. For example, in addition to tuition and mandatory fees, you can use 529 college savings plans to pay for room and board in most cases. Books and supplies and college-related computer expenses are examples of additional qualified higher education expenses. 529 savings plans can also be used for qualified expenses at certain trade schools and similar training programs.
And, although the prepaid versions of 529 plans typically can’t be used to pay for room and board, these plans can be a great way for many families to save for college tuition and fees, potentially combining a prepaid plan with a 529 savings plan to cover college costs.
3 Tips for Saving for College In a 529 College Savings Plan
1. Start making contributions as soon as you can.
One of the biggest advantages for college savings is time. It is important to get started as early as you can. The earlier you start saving, the more time there will be for earnings to potentially compound and the more money you are likely to have in 10, 15 or 18 years when your student is ready for college.
Research from numerous financial institutions shows that more and more parents are starting to save for higher education when their children are toddlers or younger. Of course, keeping other financial priorities such as emergency funds and retirement savings in mind is important too, but the early college savers have the right idea.
2. Set up automatic monthly contributions.
You can open many 529 plans with a low minimum initial contribution, such as $15 or $25, and select a dollar amount for ongoing contributions. Setting up an affordable automatic monthly contribution from your bank account will help you stay on track, and you may not even miss the money using this strategy. Even if you are unable to save enough to pay the full college bill, it makes sense to save as much as possible given your family’s financial situation.
This simple estimated comparison shows why:
- Saving $1,200 per year ($100 per month) and assuming a 4% rate of return (and tax-free growth) over 18 years may provide approximately $30,775 to pay for college.
- Conversely, borrowing $30,775 at the start of college with a 5% interest rate and a 10-year repayment term would require a monthly payment of $395 (starting six months after graduation) and would include $16,718 in overall interest over the life of the loan. The total amount to be repaid would be an estimated $47,493. (You could save quite a bit of money on the loan by paying interest while in school, but the interest would still be considerable).
Saving a dollar today is better than borrowing one tomorrow. ®
3. Use crowdfunding to give your college savings assets a boost.
Encourage grandparents, other relatives, and friends to help with your education expenses, especially when it comes time for them to think about birthday and holiday gifts. Many 529 programs have platforms and other tools that make it easy to get your extended family involved. Both the contributor and recipient will feel great about such a meaningful gift—an important investment in the student’s future.
4 Key Benefits of a 529 College Savings Plan
1. No income limitations.
There are no income limitations associated with the 529 plan. Although 529 plans have maximum contribution limits or plan cap levels where contributions need to cease, these caps are very high, exceeding $300,000 for most plans.
2. Tax-free growth.
529 plans offer the tremendous benefit of tax-free growth and the ability to withdraw the savings without paying tax as long as they are used for qualified education expenses, which are broadly defined to include most expenses related to college. In addition to federal tax advantages, many states offer state tax benefits as well.
3. Easy to switch beneficiaries.
Some parents are concerned that their child may not attend college or there may be money left over. If that happens, the account owner may change the beneficiary on the account to another relative, including naming themselves. Withdrawals for nonqualified expenses incur a 10% penalty and require taxes to be paid on the earnings.
4. Among the better savings options when considering financial aid.
Families concerned that their savings may affect their eligibility for need-based financial aid should consider 529s. On the FAFSA (Free Application for Federal Student Aid), money saved in a 529 plan owned by the parent (or by the dependent student) is assessed at a maximum of 5.64%. For example, $10,000 saved in a 529 could end up reducing financial aid eligibility by $564. This is generally much better than having money in a standard savings account in the student’s name, where it can be weighed against financial aid eligibility up to 20%. The 529 generally provides a smart vehicle for college savings given financial aid regulations for higher education.
Saving for college is an important way to minimize college debt and saving in a 529 or other tax-advantaged account generally works best for most families.
Disclosure: Any calculations or projections in this article are estimates and are hypothetical illustrations only. Simplifying assumptions and rounding may be included.