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Saving For College with 529 Plans

We’ve all heard the seemingly exaggerated expectations for the cost of a college education in 20 years. “A four year college is going to cost you $500,000 (if our currency still exists then) and one hovercraft!”  

Seriously...hovercrafts?

It seems ridiculous, and I’m certainly hoping that something is done to stem the dramatic increase in tuition costs and our future dependence upon hovercrafts as currency.  But given that both of these things seem out of my hands, I wanted to be as prepared as possible to help facilitate my kids’ college education.

So, with a toddler and the recent (surprise!) addition of twins, I started looking closely at college savings options and was immediately drawn to “529 savings plans."  Here's a brief overview of what I discovered.

Key Benefits of 529s

529 plans offer some solid income tax breaks. Although your contributions are not deductible on your federal tax return, your investment grows tax-deferred and distributions to pay for your child’s (the beneficiary) college costs can be taken tax-free. You, the donor, stay in control of the account. You decide when withdrawals are taken and for what purpose. Most plans even allow you to reclaim the funds for yourself any time you desire with no questions asked.  However, the earnings portion of the "non-qualified" withdrawal will be subject to income tax and an additional 10% penalty tax. Compare this level of control to a custodial account under the Uniform Transfers to Minors Acts (UTMA) and you will see that the 529 plan gives you much more flexibility in how your investment is used. If you want to move your investments around, you may change to a different option in a 529 savings program every year (program permitting) or you may rollover your account to a different program.  Generally, there are no income limitations or age restrictions either. And if you are thinking about going back to college or graduate school in the future, you can even set up a plan for yourself.

Prepare for Ups and Downs

With all of this in mind, I set up a 529 account for my son this year and put a chunk of money in to get it started.  Then the next week I watched the Euro zone crash unfold and saw my account lose 15% in a week. Human nature dictated that I panic and pull my money out at that point.  Of course, this would have been absolutely the wrong thing to do. Remember that your 529 account is going to fluctuate with the volatility in the marketplace and global economy.  This is normal, so be prepared.  Most financial advisors would encourage you not to worry about short-term gains and losses, but to keep putting money in the account regularly and checking on it periodically.  (A few weeks later, my new account had regained its losses and then some.) If your child is young or your intended beneficiary will not be needing the money for a long time, you can afford to be aggressive in the beginning and then shift into a more conservative program as you draw closer to withdrawing the money.  

The most important thing, however, is to start as early as you can and let your money and the market work for you. Of course, your other option is to start investing heavily in hovercrafts.  Which one sounds more promising to you?

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Joshua Heckathorn's picture

Joshua Heckathorn was President of Creditnet, is a credit expert and has been featured on CNNMoney, FOX Business, Yahoo Finance, The Street, and many other national publications during the past ten years.  He received a Bachelor of Science in Management (Finance) from Brigham Young University's Marriott School of Business and earned his MBA from Seattle University.

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Comments

KenM's picture

Spencer, good article. If college prices go up just 6% per year, over the next 20 years prices will almost triple. Since a private college can now easily be $40,000 per year or more, the $500,000 is not out of range at all. Starting to save now with 529 accounts is exactly the right thing to do. Maybe just one hovercraft, as well. Hopefully you live in a state that will give you a state tax deduction also.

Good luck,

Ken