| July 11, 2018

Last updated: September 13, 2018

College, Money & Career, Personal Finance

Saving for Your Kids’ College Education: A Primer on the 529

saving for college

Should parents help pay for their kids’ college education? It’s an issue folks have varied and strong opinions on, but if you fall into the camp that plans to pay for all, or part, of your children’s tuition and expenses, you’ll want to start budgeting for that future outlay as soon as possible.

Among all the big expenses in one’s life, paying for college is among the greatest — sometimes even matching that of a house. Figuring out how to save that money, then, becomes a nagging question on nearly every parents’ mind, almost from the time a baby first arrives. And with skyrocketing tuition costs, the prospect of saving becomes even more daunting.

Is there a best way to approach it?

Lucky for you, the vast majority of financial experts agree that there is: the 529 investment plan. While I’ll get to the details of what exactly a 529 is a little later on, let’s start with an overview of when you should start saving, what your specific goals might be, and how much you need to save.

Start Right Away!

One of the biggest mistakes people make in saving for their children’s higher education is not starting early enough. You might only think of it once a kid hits double digits, but by then you’ve lost out on a decade of saving (and investment/interest accumulating).

Really, you should be starting as soon as you have a baby in your arms. Yes, you don’t know anything about who they are or what their own education may look like, but it’s far, far better to start saving early and not necessarily need the money than to need the money and not have it. It’s actually very easy to start saving when you have a new baby because you’ll be rearranging your financial life anyway between childcare expenses (if applicable, of course) and other child-related costs — of which there are plenty. You’ll be taking a close look at your budget, so why not factor a small monthly deposit into your child’s future?

You might be asking if you can start saving before a child is even born or conceived. Of course you can, though it’s just riskier because plans for children don’t always work out as expected. To open a 529, you need to provide a social security number and a beneficiary. You could always just make yourself the beneficiary though, and transfer it to your child once they come along. There’s no problem with starting saving early, though it generally makes more sense to wait until there’s an actual baby on the scene.

What’s Your Goal? What’s Your Specific Situation?

The first thing to think about when it comes to saving for your kids’ college is what your specific goals are for doing so. You don’t actually want to think about your children’s goals, because you’re starting too early for them to have goals. That’s just the reality.

You first need to take practical considerations into mind. If you and/or your wife don’t make much money, it’s not very realistic to want to save the entirety of an elite private school tuition. You also need to think about the number of kids you have (or want) and how that will impact how much you can save. Even if you make a good amount of money, if you have 5 kids, you likely won’t be able to save 5 private school tuitions.

Second, as alluded to at the outset, you need to think about your own parenting values. Do you want to be able to provide 4 years of higher ed to your kids? Or do you want to provide perhaps half and allow your children to figure out the rest for the sake of building financial literacy and independence?

There’s no right or wrong way, and folks have very different views on the matter. There are successful people and unsuccessful people who have both had educations provided for them and who’ve had to work and get loans. It really comes down to your ideas as the parent.

How Much Do You Need to Save?

In the midst of this conversation it’s important to realize that you shouldn’t by any means put yourself in debt to pay for your kids’ college education. That’s one of the other big mistakes that every financial expert observes (besides not starting early enough). It’s just not worth it. There are other ways to pay for an education, be it grants, loans, student work programs, etc. Debt is too big a burden, especially as you age.

Recommendations for how much to save are all over the board. Fidelity Investments advocates for saving $2K per year, per child. That’s about $166/month, and if you save for 18 years, you’d have $36,000 before investment gains. That’s a pretty arbitrary number though. There are numerous college cost calculators out there that will estimate how much your child’s education will cost based on the type of schooling (public in-state, public out-of-state, private) and the average 5% annual increase. For instance, an in-state public school right now costs about $20,000/year. In 18 years, a number of different calculators expect that value to be between $40,000-$50,000/year. For private school, you could be looking at six figures per year. It’s mind-numbing, frankly.  

In general, however, it’s very hard to know how much you’ll need. There’s talk of a college tuition “bubble,” similar to the housing bubble that crashed in 2008; student loans are being given out like candy, and over 10% of those loans are in default (that number is expected to rise dramatically and could hit 40% by 2023). If that bubble does burst, things could drastically change. The rise of online courses and the ease of technology could also change the accessibility of a college education; perhaps it’ll be more affordable for everyone as platforms like Coursera and edX and college-specific programs gain acceptance.

These are total unknowns, however. This means that if you’re a saving parent, you have to operate with the climate that currently exists, even if you hope and expect it to change.

Use your goals (saving for a public school tuition, for instance) and use the various calculators out there to come up with a rough number of what you’d like to have saved up by the time your kids hit college.

Why the 529 Is the Way to Go

According to a 2015 Sallie Mae report, most families save for college by plunking money into ultra-safe, low-return options like savings and checking accounts. There, your interest return is minimal — under 1% in most cases.

While this route is obviously safe, it won’t get you far. College costs are growing at about 3-5% per year, outpacing inflation and even cost-of-living raises that are common in many industries. Especially if you start saving when your children are very young, you have time to play things just slightly more risky.

That’s where the 529 plan comes in, which as noted in the introduction, is my recommendation (and basically every other financial expert’s) for how to save for your child’s education.

So what is a 529 plan? It’s a tax-deferred investment account offered by states themselves that are made up of mutual funds. (This means that each state’s plan differs some, as do the contribution rules, tax breaks, etc.)

They are for the specific purpose of education costs for your children, and the gains and distributions/withdrawals are not taxed, ever (as long as it’s for a qualified expense, which is tuition, books, room and board, etc.). Additionally, 34 states offer state income tax breaks for your 529 contributions. The average growth of the investment is about 4-5% annually (though each state has different funds, remember), which is less than some other investment accounts, but still in many years outpaces the rise of college tuition costs. You can and should choose an age-based plan that shifts the risk as the child ages, meaning it becomes more conservative as college approaches, in order to allow for market losses.

529 plans always have a single designated beneficiary (though this beneficiary can easily be changed). This means that when you open the account, you have to put it in someone’s name, typically your child’s (though as mentioned above you could open it in yours). When you have more than one kid, you can either still put money in a single account and simply change the beneficiary when the first one finishes college (if your spacing between kids allows for that), or you need to open additional plans. The good news is that money can be transferred between plans depending on the needs of the kids, or as mentioned above, you can just change the beneficiary (say one doesn’t go to college, or just a 2-year college; maybe one gets a full scholarship and doesn’t need the money that’s been saved up).

You can pull the money out, but there’s a 10% penalty, on top of now being taxed on the gains. There is then a risk with this kind of account; if your child dies, becomes incapacitated, or simply decides not to pursue higher education at all, you could transfer the money to another child or even a grandchild, but absent those options, if you don’t end up needing the funds for an education-related purpose, and remove them for something else, you will lose money. If you’re more risk averse, and less bullish on the chances of your child going to college, you might consider putting your savings in a regular index fund instead; but then, remember, you won’t get the tax benefits of a 529.

Ultimately, the 529 plan is versatile enough to cover basically any life scenario, and offers far more education-specific benefits than any other savings/investment plan out there. For just about everyone who sees college in their child’s future, and plans on paying for all or part of it, it’s the way to go for saving for your child’s post-secondary education.

If you decide that this is indeed the best college savings route for your family, how do you go about opening an account? You can Google “[your state] 529 plan,” or head to the very handy savingforcollege.com to view details and enrollment links (all around, that site is a great resource for more details on this topic). Note that some states offer two different plans; you’ll have to look at the fine print to see which is better for your specific situation.

I realize there are a number of other details that I didn’t cover here — Can other people make contributions to your children’s accounts? Are there minimum/maximum contributions? — but again, each state is different, and you’ll just have to do your own research. You can often buy into a plan through a financial advisor, but the fee is often higher than going through the state itself. Most states make it really easy to set up an account and get started, so don’t put it off even if you think you’re financially illiterate.