Most parents hope to see their children grow up to be financially better off than they were. And for millions of Americans — some with children, and some who one day might have them — one focus is helping save for the cost of a college education.
Perhaps the most effective financial tool parents can use for this purpose, a 529 college savings plan, is a tax-advantaged saving and investment account. Also called a qualified tuition plan, a 529 plan is similar to an IRA, but for education expenses.
"If you have a hard time saving, a 529 is a good idea," says Niv Persaud, a certified financial planner and managing director at Georgia-based Transition Planning & Guidance.
As with most long-term savings plans, it's good practice to contribute small amounts to a 529 regularly, preferably with each paycheck. Before you calculate how much you need to save from each paycheck, though, you need to figure out your goal amount — and that may not be straightforward. You'll need to think about kind of college education your newborn might want 18 years from now, as well as that future cost.
Using a calculator can help. The one at Saving for College, for instance, projects that the cost of a four-year private college education could end up being about $408,844 for a child born in 2020. Depending on how much you earn, scholarships and grants can lower your goal amount significantly: For example, a family earning $100,000 a year might expect to need around $241,500.
Mark Kantrowitz, vice president of research at Saving for College, suggests different goals depending on what type of school your child might attend: Try to save $250 per month for a public, in-state four-year university, $450 for an out-of-state four-year public university, and $550 for if a private four-year school is your child's goal.
On a per-paycheck basis, that works out to roughly $115, $208, or $254, respectively.
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Don't be afraid to start small, Kantrowitz says. Even if you can't make big contributions now, "save whatever you can." since every dollar you put aside is a dollar less you or your child might have to borrow.
Whatever college you pick, the full price of a four-year education, including tuition, books, fees, and room and board, is almost certainly going to cost more 18 years from now than it does today.
Generally, "college costs go up by almost a factor of three over a 17-year period," Kantrowitz says. So "you should set your savings goals accordingly."
Because the money in a 529 plan is invested and subject to the ups and downs of the market, your account may accrue more or less than you anticipate. The good news is that if you end up with more than you need — say, because your child earns scholarships or attends a cheaper school — you can transfer the balance to another child or a relative. You also have the option of withdrawing the money, although you'll pay taxes and fees on any investment growth.
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"The 529 plan has become the primary vehicle of choice" for college savings, says Justin Halverson, a financial advisor at Minnesota-based Great Waters Financial.
You can contribute money regularly to the account, which will grow tax-free and can be withdrawn tax-free for qualified education expenses. Many states also offer tax breaks and incentives for contributions.
So your contributions will grow and you can take advantage of the power of compounding. That effectively supercharges your savings.
Another plus is that friends and relatives can make contributions, too, not just a child's parents. "If your child is having a birthday party, instead of gifts, you can have guests donate to the 529," says Persaud.
Though there are typically management fees and costs associated with these plans, experts say they're valuable tools for parents. And even small contributions to these plans, over time, can add up.
College savings plans like 529s can be powerful, but experts are adamant that it's key to start saving early, if at all possible, because time is the most important tool on a parent's side. "It's one of those things," Halverson says, where "the sooner you can [start contributing] to it the better, and the more you can save, the better."
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