Beginner’s Guide to 529 College Savings Plan
In this Beginner’s Guide to 529 College Savings Plan, you will learn what it is, how much should you invest, where to open an account and other valuable advice.
“An investment in knowledge pays the best interest”
-Benjamin Franklin
According to the US Bureau of Labor Statistics, college graduates on average earn 65% more than high school graduates ($1173/week vs $712/week). In addition to the time and dedication for college, this also does not come cheap.
Sadly, the average college student is estimated to start their work career with over $33,000 in debt. As a parent, you can plan ahead to help lessen this debt using the 529 College Savings Plan.
Prior to starting a 529, assess your current financial situation: Do you have any outstanding credit card balance or other high interest debt? Are you on track for retirement (rule of thumb: 1x salary savings at age 30, 3x salary at age 40)? Do you have an emergency fund (3 months of salary)?
If you need to work on this first, hit the pause button and take a look at the following article (Strategies to manage your money and grow your nest egg). If you are good to go, read on.
What is the 529 College Savings Plan?
The 529 is a tax-advantaged savings plan (savings grow tax-deferred). For college students, 529 qualified withdrawals can be used for tuition, fees, books, supplies, room and board and computers. Beginning in 2018, up to $10,000 can be withdrawn for tuition at elementary and secondary schools.
How much should I plan for?
According to US News, the average cost of tuition is $41,426 for private colleges and $11,260 for state residents at public colleges in 2019. Due to inflation and skyrocketing college costs as well as factoring in room and board, it is not out of the realm to expect overall private college costs to total over $400k and public college costs over $200k in 2038 (project 18 years from now assuming you are new parents).
Saving Strategies: Lump Sum vs Monthly savings Plan
Lump Sum
Doing well financially? Grandparents or others able to contribute? Consider a big lump sum to start – this will allow you to sit back and let time and the power of compound interest work for you. Using napkin math (assume 7% interest), putting in lump sums of $30k or $60k could get you $100k and $200k respectively as your kid turns 18.
If you go this route, talk to a tax accountant to help you with this approach (2019 gift limit is $15,000 per individual). Also be aware there is a ‘super fund’ policy that allows as much as a $75k gift in one year.
Monthly Savings Plan
Need financial flexibility or saving up a lump sum for more urgent purchase (house, car)? Consider a monthly savings plan or yearly contributions – slow & steady can also win the race. Assuming the same 7% interest, putting in monthly contributions of $240 and $475 could get you $100k and $200k in 18 years.
One big factor for favoring smaller contributions is checking whether you live in a state that allows income state tax benefits for 529. If there is a limit (New York is $5k per individual), then consider to capitalize on this every year).
Where should I open up my 529 account?
As mentioned, some states offer tax breaks for those that fund the 529. To see if you qualify, please reference PolicyGenius’s Saving for college: A state-by-state guide to 529 plans article.
If you have the option to open an out-of-state 529 account, look for the lowest fees and highest performance funds since you will utilize this site for many years. The SavingforCollege’s Best 529 plans of 2019 article offers a great starting point.
For me, I was one of the lucky ones that qualify for an out-of-state 529 account. I ended up choosing the New York’s 529 College Savings Plan. It has been a great option for us with no complaints thus far. For our oldest kid, the money is in the aggressive age-based fund and has averaged 8.5% gains for the last 5 years.
What should I invest for my 529 account?
The stock market has historically averaged 10% per year. If you start early with the 529 account, you will want to maximize your gains in the beginning as well as minimize risk as your kid gets closer to college.
Here are easy ways to do this:
- Invest in an Exchange Traded Fund (ETF) that follows the stock market. As an example, SPY tracks the S&P 500 and QQQ tracks the top 100 Nasdaq stocks. As your kid approaches college, then shift to more conservative, less risk funds.
- Invest in a Target Date-Fund. This fund becomes more conservative as it gets closer to your kid college age automatically shifting to lower-risk investments like bonds thus limiting big losses.
Look for these options after opening your 529 account. If you would like to learn more about ETFs, Target Date-Funds and other investment strategies, read How to Invest: Stock Market Strategies.
Savers Remorse
For the Saving Strategies approach, don’t feel bad about underfunding the 529. It is not the end of the world and you are back in the realm of normal people that depend on college scholarships, need-base aid and student loans.
What if my kid never goes to college or if I have leftover funds?
Before considering taking money out as a non-qualified withdrawal (subject to income tax & 10% penalty), there are other viable options:
- Changing the beneficiary to another sibling or even yourself if you plan on pursuing higher education
- Saving the fund for your kid’s graduate school
- Holding the fund for future grandkid
As seen with the power of compound interest, you will definitely be a hero for your future grandkids.
A gift for the wise
One of the best practices my family has adopted is to include 529 money with a small gift for Birthdays and Christmas for the nieces and nephews. During the early years, an expensive present is not necessary at all. Case and Point: my firstborn was more interested in the cardboard box than the actual present during his first birthday.
Some college funds allow for direct deposit through the Ugift 529 website. This has made it super easy to transfer cash presents to other’s 529 account directly. As an alternative, you may want to send a check to the account holder so they can do the deposit and get the tax write-off.
I love to give cash and provide guidance to open a 529 as a gift for my friends’ newborns. A $200 529 gift can grow to $700 at age 18 – a nice way to start.
Summary
Here are the key points from the Beginner’s Guide to 529 College Savings Plan:
- If you have high-interest debts or lacking retirement savings, pause on saving for the 529 College Savings Plan for now.
- Two common strategies involve Lump Sum and Monthly Contributions. Determine what makes the most sense for you and start contributing.
- Check whether your state offers tax deductions and whether you need to open an In-State account or have flexibility for any account.
- Contribute and save away! Know that you have future flexibility to change the beneficial, save the account for higher education costs or even it pass down to your kid’s future kids.
- For birthdays and holidays, consider giving a 529 contribution as a gift and a link to the 529 College Savings Plan Guide. You are providing them the future gift of knowledge which is priceless!
Disclaimer: The 529 college fund is an investment and you may lose money. Do your independent research and rely on your tax accountant and financial advisor for professional advice.
About DadMBA: Through his schooling (he does have a MBA) & more importantly being a Dad, he has provided practical advice to family & friends on finances & other life topics. He loves helping others thus the creation of DadMBA.
