Getting starting with a college savings plan for the child in your life doesn’t have to be confusing. Here are some tips.
College expenses today average more than $35,000
College can be a huge expense for families with children today. According to Education Data (link opens in new tab), “The average cost of college in the United States is $35,720 per student per year. The cost has tripled in 20 years, with an annual growth rate of 6.8%.” If the cost of college triples again in 20 years, that means for a child born in 2021, college may cost more than $100,000 per year. How can a typical family afford this expense? One way to save for college is a 529 college savings plan.
529 college savings plans can be a place to save for college
And it doesn’t have to be that complicated to get started opening an account for the child in your life.
So, what is a 529 college savings plan? Simply, it’s a special type of investment account that allows after tax contributions and tax-free withdrawals when the funds are used for education expenses. This means that the growth in the account can be tax-free.
Examples of education expenses
The definition of education expenses has changed over the years as Congress updates its laws. But this can mean many types of expenses, such as:
- College tuition, room and board (at an accredited college or university).
- Computer or internet access if used for education purposes.
- Books and fees for college.
- Trade school or other types of qualifying post-high school higher education.
- $10,000 of student loan repayment.
- K-12 private school tuition up to $10,000 per year.
- This list is not comprehensive; check current laws for more details.
Three tips to help get started on a 529 college savings account for the child in your life.
- Check out your own state’s 529 plan. There are sometimes tax benefits to participating in your state’s plan, with contributions to the plan excluded from state taxes – this varies by state so check out your state’s rules. For example, the Illinois Bright Start 529 (link opens in new tab) plan offers Illinois taxpayers the ability to deduct contributions to their plan; for single taxpayers up to $10,000 per year and for married taxpayers up to $20,000 per year. Saving For College has a tool for comparing different 529 plans (link opens in new tab).
- Fees. A lot has been made of fees associated with 529 college savings plans. Paying high fees can make it more difficult for funds in the plan to grow. Check out the fees associated with the plan you are considering. Many plans have no participation or annual fees, but they do have investment management fees which you pay depending on the type of investment you choose. Check into the fees, but also know that fees are only one aspect of the story. Read on.
- Investment Options. Look into what investment options are available in the plan you’re considering. Many plans offer target- or age- based options that are relatively easy to select. You choose an investment based on the age of the child or the year they will start college, along with your desired risk tolerance such as aggressive or moderate. If you’d like to build your own investment portfolio, many 529 plans offer that as well, allowing you to choose amongst a variety of investments like cash, bonds, real estate, US stocks or foreign stocks. Again, as an example here’s a link to Illinois Bright Start which provides a simple explanation of the types of investments available within that plan.
- Account Setup. Once you’ve chosen the 529 plan that’s right for you, the next step is setting up an account. You’ll be the owner of the account, but it will be set up “for the benefit of” a minor. If the child ends up not going to college, you can change the beneficiary to virtually anyone related to your child (link opens in new tab), which is another aspect of the flexibility of 529 plans. You should also identify a contingent owner in the event of your death or incapacitation, but typically this should be an adult or entity and not the minor child. Talk to your estate planning attorney for recommendations in your particular situation.
- Funding the Account. Choose the level of funding that’s right for you. You’ll need to consider both what you can afford to contribute, as well as how much you think you would like to pay for the child’s college expenses when the time comes. Estimating how much college will cost for the child can be complicated but there are tools on most state’s 529 plan websites to help. Talk to your financial advisor about your specific situation.
Initial and ongoing contributions
When you fund the account, you can make an initial contribution, and then set up ongoing monthly contributions as well, which can be convenient for cash-flow reasons. I also find that setting up automatic contributions makes it more likely that contributions will continue, since it’s not something you need to decide every month.
There is also the option of superfunding a 529 account. More about that here (link opens in new tab).
As always, talk to your financial advisor about your personal situation. The content here is not intended as personalized financial advice.
