When I lived in NYC and my children were born, my friends warned me that I needed to start preparing now so that they could get into a good preschool. Now? Really? We just got home from the hospital. Unfortunately, in NYC, they weren’t far from the truth. You had to figure out where you were going to apply and how in the world you were going to pay for it.
While we don’t live in NYC anymore, the same plan seems to apply for sending your kids to college. The expenses are skyrocketing and don’t seem ready to slow down anytime soon. So what’s the best way to pay for it?
I started saving in a 529 plan for my children as soon as they were born. I’ve added a little bit to the account each month they’ve been alive. They are only in elementary school, but we’ve already put a dent in their future education costs. The contributions happen automatically and I’ve been doing it for so long, I don’t even notice the money coming out each month anymore.
What is a 529 Plan?
Think of a 529 plan sort of like an investment piggy bank for college. You get to contribute to the college savings account of your choice. Each state has their own option. While you do not have to use your state’s option, there may be a tax benefit for doing so (a little more about that later).
Why Does Your Child Need a 529 Plan?
College is expensive and every year the price goes up. According to the College Board, expenses increase by an average of 5% annually. That means that if your first-grader is 6 years old now, that $10,000 a year education will cost $16,478 by the time they’re ready for their freshman year in 12 years. That’s HUGE! I don’t know about you, but that’s an awful lot of money to try to come up with all at once.
Benefits of a 529 Plan
- The funds that you contribute to a 529 plan grow tax-free
- If you have more than one child (or if you’re interested in going back to school yourself), the funds can rollover to another beneficiary
- Anyone can set up a plan on behalf of your child (rather the grandparents to set up a 529 plan rather than buying that new toy for Christmas….little Johnny will thank you later)
- Depending on your resident state, you may be eligible to receive a tax deduction for your contributions
- You don’t have to worry about paying for college all at once! The earlier you start, the easier it will be to save to cover the entire expense
How Do I Set Up a 529 Plan?
The set up varies by financial institution and is very similar to setting up an online investment account. You’ll provide your information, information related to your child, and make decisions regarding your investment choices. In my cases, I selected the fund based on when my child would be entering college. This means that the funds are invested to grow aggressively while they are young, and become progressively less aggressive as they get closer to college age. This helps to protect against the chance that the account will lose value as they prepare to use the monies.
Most financial institutions provide an option to set up an account online and so you could even do so in your pajamas.
How Does a 529 Plan Effect My Taxes?
How a 529 plan effects your taxes is really dependent on your resident state and the plan that you choose. While there is currently not tax benefit on your Federal return, many states offer a tax deduction for contributions that you make. That means that if you earn $100 and contribute $1 to your 529 plan, you would have $99 in taxable income (rather than a credit, which directly reduces the amount of taxes you pay). You’ll want to check your state’s tax plan and talk with your tax advisor about any available deductions.
Please note that once your child gets to college, playing for expenses with the funds from a 529 plan will not prevent them (or you) from taking advantage of educational credits, should you meet the other qualifications.
What if My Child Doesn’t Go To College?
While you’re saving for college, your child may become a young entrepreneur and make millions from the company they started. Alternatively, they might have earned scholarships that cover he full cos of their education. If that happens, congratulations! After you finish celebrating, you may be wondering what’s going to happen to all of that money. Rest assured all is not lost. As I mentioned earlier, the funds can roll over to another family member to be used for educational purposes.
If there is no one else in need of the funds, you can withdraw them from the account. Unfortunately, any withdrawals that are not used for qualified educational expenses are subject to tax assessment in addition to a 10% penalty on the earnings of the account.
Paying the penalty is not fun, but if it’s because you don’t have to pay for college, I’m sure it’s worth it.
Are There Risks Involved?
As with any type of investment account, there is always a risk that your account could lose value. You’ll want to thoroughly research any investment that you make and if you are still uncertain, consult with a financial advisor.
Trying to figure out how to pay for college is stressful, but with a little planning, you can make things much easier when it’s time to drop your child off for their freshman year.
Have you started saving for your child’s education? If not, be sure to add it as a part of your budget.