The rising costs of college can be daunting for parents planning for future education expenses and although there are a variety of ways to save for college, experts say many families are overlooking an extremely accessible route to help them reach their goals: 529 college savings plans.
Americans currently invest a record $179 billion in 529 college savings plans, but less than one-third say they know what 529 plans are, a six-point dip from last year, according to a recent survey by financial services firm, Edward Jones.
A 529 plan is a tax-advantaged investment operated by either a state or higher education institution designed to help families save for college for a designated beneficiary, typically a child or grandchild.
There are two types of 529 plans: savings plans, which allow the investor to choose from a set of investment options such as mutual funds, CDs or stable value options depending on the plan and prepaid plans, which lock in the current tuition rate and pay out the future rate when the beneficiary heads to school and are generally used at in-state schools and public colleges, but can also be converted to include private and out-of-state schools.
In addition to having investments grow tax-deferred and distributions to pay for the beneficiary's college costs federally tax-free as long as they are used for qualified educational expenses, most 529 plans also allow for flexibility in transferring assets to other beneficiaries, says John Bucsek, managing director with MetLife Solutions Group.
“Should your child decide not to go to college or they get a scholarship, the money can be used for another family member, even grandchildren,” he says.
Savings Plans vs. Prepaid Plans
It’s important to consider the differences between a savings plan or prepaid plan as well as a state plan or out of state plan.
Savings plans allow families to save as much as they want or can be used at any college in any state, while a prepaid plan only applies to that specific state’s public colleges or universities, according to Anna Behnam, an Ameriprise financial advisor.
“If a parent knows that their child is planning to attend (or plans to require that their child attend) a very specific in-state school, he or she should consider a prepaid plan,” she says. “If a parent is not sure or does not want to tie the child to any specific state prematurely, then he or she should consider the savings plan because it’s more flexible.”
Savings plans may only be administered by states, and families should first look into their own state plan’s offerings to determine if it makes sense for their situation and offers a tax deduction or a tax credit.
“Many states offer meaningful incentives to their residents for investing in the ‘home state’ plan,” says Beth Walker, financial planner at Strategic Wealth Associates. “It’s definitely worth a little effort to find out if your state offers any ‘extras’ for saving those dollars earmarked for college.”
Thoroughly researching prepaid plans is equally as important, as they come in several forms and conditions can vary greatly from plan to plan.
“Some prepaid plans cover tuition and fees only, while others cover all qualified higher education expenses,” Walker says. “The essential benefit is that you lock in those costs: once you've paid the plan's price, it becomes the obligation of the plan to deliver the promised benefits down the road.”
Define Contribution Goals
Although the notion of starting to save for college can be overwhelming, looking at an education investment planner to project the total cost of college and taking inventory of household expenses and savings can help better define contribution goals, says Jeff Howkins, CEO of Sallie Mae’s Upromise Investments.
“You don’t have to have a tremendous amount of disposable income to open and continuously fund these,” he says. “The education investment planner lets you look at the total cost of college so you can figure out how much money you are going to need and helps you come up with different plans to pay for that.”
Parents should ask relatives to contribute to the plan in lieu of giving gifts, helping to augment savings and also take advantage of the federal gift tax exemption, recommends Howkins.
Determine Risk Profile
To pick the right savings model, families should compare plans, determine their investment time horizon and find what works with their financial needs. “[Parents] need to also look at what are the ages of the children because you want to make sure you’re putting the children’s savings in the appropriate risk-managed investment options based on their age as well,” says Howkins.
Finding the right plan plays an important role in making paying for college achievable for families and their students without having to take on heavy debt later on in life, says Walker.
“The best plan for any family is the one they can start and finish--go with a plan you understand, fits your need for simplicity or complexity and makes it easy for you to ‘stay the course’ in terms of setting money aside for education.”