If you’re a parent, it might be hard to think about the future between cereal spills and crayon masterpieces on the wall.
But the cost of college is rising. By 2030, it’s projected to cost more than $205,000 for four years at a public college.
So, how do you prepare for your child’s future now? One of the best ways is with a 529 plan.
What is a 529 plan?
A 529 plan is an investment vehicle that allows you to save for your child’s education. There are two types: a college savings plan and a prepaid tuition plan. This article will focus on the former, which is more popular. But if you’re curious, you can check out the differences between 529 plans.
With the 529 college savings plan, you contribute money throughout your child’s life into an investment account. Then, when your child is ready to attend college, they can use the money for tuition, books, room and board, and other related expenses (even a computer).
The difference between a savings account and a 529 plan is the latter is invested into the stock market — which means it has the potential to earn more returns than a savings account.
Let’s say you contributed $100 per month for 18 years. Using our simple savings calculator, here’s what you’d end up with:
- In a savings account at 1.00% interest (which you’d get only with a high-yield savings account), you’d have $23,655 by the time your child went to college.
- In a 529 savings plan that earned average returns of 7 percent, you could have nearly double that amount: $43,072.
And don’t worry: It’s not like you’ll be picking and choosing stocks yourself. Each state’s 529 plan is managed by financial advisors. Most plans will start out riskier (more stocks and fewer bonds) and become more conservative (fewer stocks and more bonds) as your child nears college age.
Of course, you always expose yourself to risk when you invest in the market. If the ups and downs make you nervous, check out these alternatives to 529 plans.
The pros and cons of 529 plans
Consider these pros and cons when deciding if a 529 plan is right for you.
- Tax-free for education: Your child can remove the money for qualifying education expenses and won’t have to pay taxes on the earnings.
- State tax credits: Some states offer a tax credit for a percentage of your contributions. Here’s more on the tax benefits of 529 plans.
- Minimum deposits: Some states require you to open a 529 plan with at least $1,000 or fund the account with a minimum amount per month.
- Limited to education expenses only: If your child doesn’t attend college, your 529 plan’s earnings will be subject to taxes and a 10 percent penalty. One way to use the leftover 529 plan (and avoid the fees) is by passing it on to a sibling.
How to sign up for a 529 plan
Here are the steps you should follow when you’re ready to sign up for a 529 plan.
1. Choose your 529 plan
Since each state has its own 529 plan, most people sign up for the 529 plan where they live.
Although you’re welcome to cross state lines when you sign up for a 529 plan, most states won’t give you a tax credit if you use an out-of-state plan. That said, if you’re in a state that doesn’t levy an individual income tax or offer tax benefits for 529s, then you should shop around for the plan with the lowest fees and highest returns.
To compare plans, try this tool from SavingForCollege.com. It offers in-depth information about each state’s plan and allows you compare plans side by side.
You also can open a 529 plan through a financial advisor — and not the state — but doing so usually means higher fees.
2. Open and fund the 529 plan
Once you choose the 529 plan that’s right for you, all that’s left to do is open it. You usually can do so online, and it’s helpful to have personal information — like Social Security numbers and birthdays — on hand.
You’ll also need to fund the 529 plan with a transfer from your checking account. Many states have no minimum contribution amount, but others require a transfer of at least $250.
One thing to note is you shouldn’t be saving for your child’s education over your retirement.
Although it might seem selfish, it makes financial sense. There are many ways to fund a college education (loans, scholarships, etc.), but no one can fund your retirement except you. So, only create a 529 plan if you’re already making good headway with your retirement fund.
3. Set up automatic contributions
Now is also a good time to set up regular contributions to your 529 account — even $25 per month adds up over the years. To see how much you should contribute, use this college cost calculator.
Going forward, you could ask family members to donate to your child’s 529 plan in lieu of gifts. Although it might take some getting used to, your child will be grateful by the time college rolls around.
Education is one of the best gifts there is. And if you’d like to help bestow it upon your child, a 529 plan might be the way to go.
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