Student Loan Debt Is Out Of Control
College is expensive and the tuition varies drastically based on the choice of school. Students are taking on more and more debt. This results in postponing life decisions after school such as purchasing a home or starting a family.
Stay The Course On Your Financial Goals
It’s best to stay the course on your financial goals before you invest for their education. This could be an emotional struggle but when it comes time to retire you won’t be able to take out a loan to cover your retirement as they can for their education. Ultimately, saving for your child’s education is a personal decision.
If you decide that you can’t currently invest in a 529 plan, I still recommend opening an account. Your child will likely receive monetary gifts throughout their childhood. With an available 529 account, those gifts can be deposited and grow. They may receive sizable gifts around birth. Deposit this money into the 529 account and let it grow for the next eighteen years.
Deciding How Much To Save
Costs are going to vary substantially based on where your child goes to school. When the time comes you may consider private school vs state school, in-state vs out of state, or a community college. If you’re worried about costs – a wise decision would be to go to a State school in your state. State schools for an out of state resident could be just as expensive or more expensive than a private school. It’s most important to not get overwhelmed. Saving something is better than not starting. Opening an account and establishing a habit of moderate contributions is the first step.
There are many calculators available to calculate savings growth over a certain number of years. There are also calculators available to estimate how much the costs of college will grow with inflation. If you’re comfortable with Excel, create your own and explore different scenarios.
I’ve provided a few different scenarios. They may be much higher than you can contribute now or much lower than your family’s needs. The important takeaway is the power of time and the beautiful effects of compound interest on your investments. The stock market will go up and down as your child grows. For an annual average return, 8% should be a conservative estimate, 10% should be moderately aggressive, and 12% is probably an aggressive expectation.
Scenario 1: $2,000 Invested At Birth For 18 Years
Scenario 1 depicts someone investing $2,000 at the approximate time their child is born. This may be a lump sum that you provide or gifts received at a Christening. This single investment could grow to approximately $8,000 at 8% annual return, $11,000 at 10%, and $15,000 at 12% all without any additional contributions. Time is powerful.
Scenario 2: $5,000 Invested At Birth For 18 Years
Scenario 2 is similar to Scenario 1. The initial investment has changed from $2,000 to $5,000. This single investment could grow to approximately $20,000 at 8% annual return, $28,000 at 10%, and $38,000 at 12% all without any additional contributions.
Scenario 3: $1,200 Invested Annually For 18 Years
Scenario 3 does not contain an initial investment. $1,200 is invested annually for 18 years. This annual investment could grow to approximately $49,000 at 8% annual return, $60,000 at 10%, and $75,000 at 12% all without any additional contributions.
Scenario 4: $2,400 Invested Annually For 18 Years
Scenario 4 doubles Scenario 3’s annual investment to $2,400 annually. This single investment could grow to approximately $97,000 at 8% annual return, $120,000 at 10%, and $150,000 at 12% all without any additional contributions.
Your scenario will differ from the graphs presented. Your time horizon may be shorter. Determine what your goals are, how many years you have, and what you are comfortable investing.
The 529 Plan Explained
What is a 529 Plan? A 529 allows you to invest after-tax dollars. The parent or account owner controls the account, not the beneficiary. The money then grows tax-free with no tax on the earnings at withdrawal. Contributions to a 529 plan under $14,000 (or $28,000 married filing jointly) are excluded from federal gift tax. This limit applies to any other gifts to the beneficiary during that year (Source: https://www.irs.gov/uac/529-plans-questions-and-answers).
The maximum 529 balance restrictions can vary by state, NY’s maximum 529 account balance is $375,000 (Source: https://www.nysaves.org/home/basics-of-529s/529-basics.html). A child can be listed as the beneficiary on multiple 529 accounts, this maximum is the total across all accounts. An example of this would be a grandparent with a separate account with your child listed as the beneficiary.
There are many states that offer 529 plans. You are not required to use the plan organized by your state but there may be state income tax deductions if you do. NY State allows deducting up to $5,000 (or $10,000 married filing jointly). If your state has no plan you can choose another state’s plan. Vanguard has a nice interactive map of the United States. When you hover over a state you’ll be provided with the relevant details for that state. For example, NY’s plan, nysaves.org, is state tax deductible, contains Vanguard funds, and has Vanguard management. As a resident of NY state, this is the plan I’m personally involved in. Vanguard is a reputable investment company and known for their low-cost funds. Note: Vanguard is not an affiliate or sponsor of this website. This website receives no compensation for the use of these links.
Locate your state on the map. If your state offers a tax deduction or credit, it may be desirable to use your state’s program. Now look at the investment options, are they low-cost and available from a reputable company such as Vanguard? You also want control over your investments, good plans allow you to pick the specific mutual funds or mutual fund classes that you’ll be invested in, as you would in a retirement account. If your state fits all these criteria, it’s probably a good option to invest within your state. If not, you may want to select a state that has good investment options.
After deciding on where you’ll open your 529 plan watch out for any additional fees. It may be possible to eliminate non-investment fees by opting for electronic statements. You can open an account in most states for as little as $25.00.
How Can The Proceeds Of The 529 Account Be Used?
The proceeds of your investments can be used in any state. The 529 is not limited to traditional 4-yr college. The proceeds can also be used at 2-yr schools, trade and vocational schools, and graduate programs. A general rule of thumb is if the school participates in financial aid programs run by the US Department of Education, the 529 proceeds can be used to pay tuition.
The proceeds are not limited to tuition and fees, they can also be applied to books, supplies, computers, and room and board. For specific details on the distribution of funds from a 529 plan, you should seek a tax professional in your state or contact the 529 plan management company.
If your child receives a scholarship you can withdraw the equivalent amount without penalty or taxes.
“I’m Worried My Child Will Not Go to School”
Some people may avoid investing in a 529 plan for fear their child will decide not go to college. College is not for everyone and there are great career paths available outside of traditional college. If your child doesn’t go to a college, vocational school, or another covered program, you are not stuck. The beneficiary can be changed to another child. If your other child already has an account, you can make them the beneficiaries of both accounts or merge the accounts.
The beneficiary can even be switched to another family member such as a niece or nephew. The IRS is a good resource for the full definition of other family members. You can also make yourself the beneficiary of the account to further your education. If these options don’t work you can withdraw the money. You’ll be penalized 10% and pay taxes on the distribution.
You should never invest your hard-earned money in something you don’t fully understand. Read, ask questions, get comfortable, and then invest. Start small, establish the habit, and increase the contributions as your budget allows.