Updated: Oct 1, 2019
As parents, and grandparents we want to give the whole world to our kids. More often than not, that includes a first-rate college education. Right now, while the little ones are still stumbling through toddlerhood, college seems like a long time away. But as we know, life moves quickly. Before we know it, our babies will be teens, submitting college applications.
If you’re like me, you want to help your kids get off to a solid start in life as young adults. For many people, this means entering the workforce with a college degree.
But a solid start to adulthood also means helping your kids avoid crushing student loan debt. With the average cost of tuition and fees sitting at more than $12,000 for public schools and $48,000 for private schools, student loans are often viewed as inevitable. They don’t have to be. With a 529 plan set up and funded early on in your child’s life, you can help your children get a head start on paying for college – even if they’re still running around the house in a onesie and diapers.
Why a 529 plan?
In today’s America, about two out of three high school graduates enroll in a four-year college. And about 70 % of students graduate with loans.
I can’t put enough emphasis on the fact that 529 plans are a fantastic way for parents and grandparents to start saving for their children's college education early. 529 plans are an easy way to save and invest your money, and they have several financial benefits:
529 plans are funded with after-tax money but grow tax-free
Distributions are tax-free as long as they’re used for qualifying education expensesA variety of expenses qualify – not just college tuition
You can use the funds for private K-12 tuitionOther people, such as grandparents, can contribute to the account.
It can be tough to determine which 529 plan best fits your family’s situation. Here are a few things to keep in mind.
Are all 529 plans the same?
Although most 529 plans act similarly, they’re not exactly the same. Depending on which 529 plan you select, you could:
Run into different expense ratios for holding the investments within the plan have different asset allocationsQualify for different tax benefits Have to adhere to different usability rulesNegatively impact your child’s financial aid eligibility
Let’s explore some of these key differences between 529 plans, and what you should keep an eye out for as a financially-savvy parent.
Here are some things to watch out for.
Fees & expenses
As is the case with every type of investment account, you’re going to have some expenses associated with your 529 plan. When comparing plans, make sure you keep track of fees. Watch for the following:
Management feesEnrollment or application fees
Annual account feesFund-based fees (or expense ratios)Account maintenance fees
Ideally, you want all of these fees to be low or non-existent. However, it’s especially important to watch for expense ratios connected to the investment options in your 529 plan. In other words, you want the expense ratios of those investment options to be as low as possible, and ideally, less than 1 % overall.
Investment options and portfolio types
You don’t have to be a professional investor or day trader to take a closer look at the funds in your 529 plan.
There is a range of investment options and different portfolio types available for you to choose from within each 529 plan. Some portfolios are managed based on when your kid is going to head off to college (age-based portfolios), and typically, the risk level will slowly decline as your child gets closer to high school graduation. However there are other types of portfolios available, so if you have questions, you may want to work with a financial planner.
We don’t live in a perfect world, and it’s possible over time for the fund to become over-invested in one type of investment. Now and then, it’s a good idea to take a look at how your assets are being allocated. You can ask your 529 plan provider (or dig in to the information available online). If you have questions about whether or not that allocation makes sense for your goals, this is another good reason to reach out to a financial planner.
Check for tax benefits
All 529 plans offer federal tax benefits. In addition, some state tax benefits may be available for investors who choose to fund a 529 plan. This isn’t the case for every state, however. If your state’s 529 plan doesn’t offer tax benefits, you may want to take a look at other states’ 529 plans – and take into consideration their tax benefits (if any apply), fees, investment options and asset allocation. You may find a better fit for your needs.
Keep in mind that even if your state does offer tax benefits for enrolling in their 529 plan, you should still shop around. If your state’s 529 plan has high fees or expense ratios, the tax benefit you receive for enrolling may not make up for the financial downsides. Always crunch the numbers before making a commitment.
Direct-sold versus consultant-sold plans
When you select a 529 plan, you have two options:
Enroll in a plan on your own and manage your account yourselfEnroll in a plan through a broker/dealer (advisor-sold)
The lower-cost option is usually a direct plan that you manage yourself. Advisor-sold 529 plans often have higher fees associated with them because you’re paying fees for both the plan and the advisor.
You may want to consider a blended approach of working with a fee-only financial planner to manage the 529 plan you’ve enrolled in directly. The fees you pay your planner will be for a comprehensive plan including cash flow management and investing or savings guidance, and won’t be tied to the sale of the 529 plan.
Be aware that a 529 plan could negatively impact your child’s eligibility for financial aid. The balance could reduce the amount of need-based aid your child can receive, and the distributions could be considered income.
However, there are several strategies for reducing the negative impact, and some states offer a workaround. For example, some states offer a scholarship incentive for students who are enrolled in their state’s 529 plan and are going to an in-state school.
Some 529 plans offer easy, user-friendly platforms to help parents and students access their funds for qualifying education expenses. However, others make the process much more complicated. I’ve heard some worst-case stories of 529 plans refusing to fund a semester’s tuition because paperwork was submitted late by the school itself. Families in those situations could be on the hook to pay out of pocket or take out loans in order to stay in school.
All of that is to say – choose a plan that makes accessing your funds easy, and learn the process ahead of time. Don’t rely on the plan administrator or your child’s school to do the work for you.
Funding your 529 plan
Once you pick a 529 plan that meets your family’s unique needs, it’s time to start planning ahead. It’s a good idea to set a savings goal that accounts for at least these things:
Annual tuition cost (multiplied by 4-5 years in school)
Room & board
Cost of school supplies and books
If the total figure feels daunting, break it into smaller, bite-sized steps.
How much can you realistically contribute this year? You could consider automating contributions when you can to start moving in the right direction. You can always increase contributions as your income or cash flow grows.
It’s important to not prioritize funding your 529 plan over your own financial needs, now and in the future.
Retirement, for example, shouldn’t take a back seat to your child’s college fund. In the long run, when you’re able to care for yourself, you’re going to be less likely to financially burden your kids – and will be able to continue to financially help them through school and beyond.
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