How a 529 plan can help pay for college

Tax-free savings can go a long way toward funding tuition, if you start early

By Penelope Wang

A 529 plan is one of the best ways to save for college. The money grows tax-free, and many states give you a tax deduction on top of that.

But many families do not take advantage of this opportunity. In fact, only 37% of families used a 529 account to help pay for their education last year, according to a 2021 survey by Sallie Mae (PDF).

“Many families aren’t aware of 529 plans, and others don’t like the idea of ​​saving in an education-only account,” says Mark Kantrowitz, financial aid expert and former publisher of the Saving For College website.

Consumer Reports did some math, with help from Vanguard, to show what you’re missing out on if you don’t take full advantage of a 529 plan. That could be tens of thousands of dollars.

Closing the savings gap

For example, if you opened a 529 account for a newborn this year and contributed $250 a month, Vanguard’s college savings calculator estimates you’d have over $113,000 when your child goes to college in 18 years old. That’s more than double your investment of $54,000.

It’s also enough to cover nearly half of what Vanguard predicts will be the $235,000 cost of a four-year public college in the state in 2040, including tuition, room and board. (current cost is approximately $91,000).

If you invest $450 per month, you would have over $200,000 in 18 years on an investment of $97,200, which is enough to cover almost 40% of the projected cost of $536,000 – as difficult as that may seem – a four-year private investment. college (current cost: $207,000).

Of course, many young families don’t have $250 or $450 a month to spend, especially with the arrival of a new baby. The average age of a 529 beneficiary when opening an account is 7 years old, according to Patricia Oey, senior analyst for multi-asset and alternative strategies at Morningstar.

No matter how much you invest, you get a big discount on the price of a college education, and who can refuse a sale like that?

You can even start with a nominal amount, say $25 or $50 per month. As your income increases and certain expenses like diapers and childcare decrease, you can pump extra money into your 529.

Even if you start late, you can progress. Suppose your child is 6 years old. If you contribute $250 a month until they go to college in 12 years, you’ll have nearly $67,000 on your $36,000 investment.

These are of course only average estimates, and your actual returns will vary depending on the type of mutual fund you invest in and the performance of stocks and bonds during these periods. (To work out the numbers for yourself, try Vanguard’s College Savings Calculator.)

Also, keep in mind that it’s hard to know exactly how much college will cost in the years to come. But a good rule of thumb is to save at least a third of the money you think you’ll need, with the rest coming from income and financial aid, Kantrowitz says.

There is yet another reason to save. If you wait to pay for your education and end up taking out student loans, the cost of education can be significantly higher than the listed price.

Say you’re a typical public college graduate with a loan balance of nearly $27,000, at an average interest rate of 4.9%. (Loan interest rates are likely to increase for the 2022-23 academic year.) You could end up paying a total of $34,207, including interest, if you make fixed payments over 10 years. That’s $7,207 more than you could have avoided paying.

“Every dollar you set aside for college can save you a whole lot more in interest payments,” Kantrowitz says.

529 other benefits

In addition to long-term capitalization, 529 savings plans offer three key benefits.

Tax breaks
As noted above, money from a 529 plan can be withdrawn free of federal and state taxes as long as you spend it on qualified higher education expenses, such as fees, books, and computers.

You may also qualify for state tax relief for your contributions, which are offered by about two-thirds of the states.

Favorable financial aid treatment
The assets of a 529 account do not weigh heavily on a student’s eligibility for federal financial aid, including student loans. Any accounts owned by grandparents or anyone else will not be considered for help at all. And assuming new federal aid rules aren’t further delayed, distributions from grandparent-owned accounts in 2022 won’t count as income for the 2024-25 academic year.

Flexibility for the future
In some states, 529 money can also be used to pay for K-12 tuition; up to $10,000 can be spent tax free. Check with your state plan to see if this is an option and what the rules allow. The money can also be used for higher education.

If your child ends up no longer needing the money for college, or chooses not to go, you can change the beneficiary of the plan to another family member or even yourself. You can also choose to withdraw the money, which will be taxed at the recipient’s rate. You will pay a 10% penalty on profit growth.

Find a plan 529

You don’t have to save in your own state’s plan; most 529s are open nationwide. But it is worth checking the offers from your home country first because of possible tax breaks.

Pay attention to the fees because low costs will allow you to keep more of the returns. The average fee for a portfolio based on age or target enrollment is 0.42%, but fees for plans that favor low-cost index funds tend to cost less than 0.20%, according to Oey. . For example, Utah’s my529 plan only charges 0.14-0.17% for age-based conservative funds.

To compare 529 plans, you can go to Morningstar’s 529 website or Saving For College.

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Consumer Reports is an independent, nonprofit organization that works alongside consumers to create a fairer, safer and healthier world. CR does not endorse products or services and does not accept advertising. Copyright © 2022, Consumer Reports, Inc.

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