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Saving For College

College costs keep rising and it seems there is no end in sight. The cost of college has been rising at an average rate of about 6% per year for decades. Research suggests that the rate of increase might be slowing, but it will still keep going up. At current rates, if you have a first-grader right now, college when your child is 18 will be twice what it is today.

Importance of Saving

I can't stress enough the importance of saving - and saving early! If you want to help your child or children attend college and don't want to leave them with six-figure student loan debt, it's time to start saving. As you know, time is a powerful lever. If you saved $350 per month for your child's education and started when he or she is a newborn, you would have saved over $135,000. If you waited until age five, you would have saved just over $82,000. If you wait until age 10 you would have about $43,000. That means that the waiting that first five years cost you $32,000 in growth. Waiting another five years costs you another $18,000.

Now, I know not everyone can afford $350 or more per month, but the point I am trying to make is that there are huge benefits to starting now.

Benefits of Tax Deferral

OK, I know you all know that you are supposed to save, but why not just put this money into a savings or investment account?

Not having to pay taxes on your investment gains every year is a great benefit. If you saved and invested the same amount in the same investments, but in one case it was a taxable account and the other account was a 529 plan, you end up with significantly more money in the 529 because you don't pay any taxes on the 529 growth, whereas in the taxable account you would have to pay taxes on the dividends and interest every year, as well as on the capital gains every time you rebalanced your portfolio. Those taxes add up.

529 Plans

You've heard about 529 plans before, I know. But they are a great tool and repetition is a great way to learn. With a 529 plan, you get to put away money after-tax, and some states actually give you a tax deduction or credit off of your state taxes to further the benefits. Then your money grows tax-deferred and if you pay for qualifying education expenses you don't pay any taxes on the withdrawals.

Further benefits include high contribution limits, currently $14,000 per year per child. If you are married you and your spouse can each put in $14,000 per year for a total of $28,000. You can even front-load your contributions. meaning that you can put five years worth of deposits into the account. So you can start the account with $70,000, or $140,000 if you are married. There are also no income limits on 529 contributions unlike other types of college savings accounts or IRAs.

There are a couple of downsides to be aware of, however. If your 529 money goes unused and you have to withdraw the money for non-educational expenses your would have to pay taxes on the gains as well as a 10% penalty on the gains. Some people keep unused funds in the account and change the beneficiary to their grandchildren, though. This money gets to grow for 18 or more years so it is a great way to help your kids pay for their children's college educations. 529 money is also counted as an asset for financial aid purposes if it's held by the parent. 529s held by grandparents don't count toward the financial aid asset calculation.