Saving for college
Throughout history, parents have used savings, unsecured loans and credit to get their children through college. Since 1996 however, a new savings vehicle has been on the market and growing numbers of parents are utilizing it. Section 529 plans offer tax-advantages for saving when it comes to college savings. One thing to remember is that college costs are not set to decrease any time soon. In fact, since the 80s, they have consistently risen straight across the board. Also, for parents who wait too long to start saving, many older savings options won’t help. For example, the Coverdell Education Savings Account has an annual contribution limit of $2,000. If parents don’t open it until a child is in high school, it most likely will only put a small dent in college funding. Finally, prepaid tuition plans sound good, but children have to go to schools that participate in the plan. That limitation could mean disaster for a student wanting a specific field of study.
The 529 Plan
State-sponsored college savings plans allow flexibility in choosing a school. In addition, parents starting to save later still have the opportunity to make a sizable investment. The Section 529 plans allow people to invest in a predetermined pool of stock and bond investments. Most plans involve dividing investments according to a given asset allocation that is determined by the child’s age. Younger children traditionally have more aggressive asset allocations and older children have more conservative ones.
The lifetime contribution limit for the 529 plan often times is greater than $200,000 and that affords a great flexibility in how much parents contribute. All earnings in the account are tax deferred and for parents living in the state when the plan is used, they also may be eligible for state tax deductions. Once the child reaches college age, the account can be used to pay for qualified higher education expenses. If money remains in the account after paying off college, the balance can be transferred to a younger sibling or other related family member headed for college.
The advantages and disadvantages of a 529
Older methods of paying for a child’s college meant dipping into savings, taking out unsecured loans or family assistance. Today, the 529 savings vehicle is offering a much less intrusive method of saving for college. The biggest advantage of the fund is that the plan is flexible and has few limits. Plus the state-sponsorship means that they are tax-deferred vehicles for saving money. The other big advantage is professional asset management. Each participating state contracts an asset management firm to handle the plan. You can find out what company your state uses by visiting SavingForCollege.com.
When it comes to the disadvantages of the plan, there are a few to note. First, the plan is funded by various stocks and bond investments. With any stock or bond-funded account, there is a risk to be aware of. When it comes to the 529 Plan, returns are not guaranteed. That means that potentially your account could lose value, or remain the same. Companies cut back on the aggressive stocks and bonds as the child ages, but risk is never completely out of the picture.
Parents also should have a complete understanding of the contribution and withdrawal rules to the plan prior to signing up. Every state has its own rules in terms of procedures, so be sure to read up on what state is applicable. There are also penalties to be aware of if withdrawals are not used for higher education expenses.
Choosing the right plan
It takes some research to find the right savings vehicle for college funding. The Section 529 plan can be extremely helpful, but there are other options to consider. A prepaid tuition plan may make it possible to lock-in on a college’s tuition rate. That can cut down considerably on savings, unsecured loans and credit needed to fund a shortfall. Coverdell Accounts may be useful for parents who start saving early and commit to saving religiously every year. What plan a parent uses needs to be individualized to their specific financial situation. Research is key in finding the right solution to the problem of funding college.