College costs have increased faster than the rate of inflation over the past several years. The higher costs are most often being met with more student loans. If you’re in a position to help your child pay for some of his or her college education, a 529 plan is the best way to do so.
I should mention that before you consider saving any money towards your kid’s college, you should be saving every penny you can for your own retirement. You don’t want to have to depend on your kids financially during retirement. In addition, there are loans, scholarships and grants for college expenses. There are no such benefits for retirement.
So what is a 529 plan? Basically, it’s a state-sponsored college savings account. Created by Congress in 1996, these accounts give families an efficient way to set aside money for college expenses. The idea is to set up the account in your name and contribute what you can each month to the plan’s investment options. The simplest option is the age-based fund, which is heavily invested in stocks when your child is very young and turns more conservative each year as the child approaches college.
It goes from being an investment account in the early years to basically a savings account when your child reaches the last years of high school. Other than putting money in each month, it requires very little effort on your part.
The primary benefit of 529 plans is that all earnings on the money you put in the plan are spent tax-free if used for eligible college expenses. These could include tuition, fees, books, supplies and equipment. In addition, some states offer a tax break on money you put into the plan.
A common misconception is that you must use your own state’s 529 plan if you want to save for college. In fact, you can use any plan in the country. Every state has at least one 529 plan, but some have several. If your state offers a tax break and the total account fees are low (generally below 0.5% annually), put the money in your own state’s plan. If not, many experts agree that Utah’s plan is the best in the country because of its low costs and investment options.
One thing you never, ever want to do is pay a commission on college savings. You want every dollar to go towards paying for your kid’s college and not lining the pocket of some stockbroker. To minimize costs, set up the plan yourself rather than going through a financial adviser. This is another reason Utah’s plan stands out. Every state except Utah has an option to go with a full-commission adviser who charges fees as high as 2.6%. If a state is willing to charge that much, can they really be trusted with your hard-earned money?
Parents, aunts, uncles, grandparents or others can open 529 accounts for a child. If the child chooses not to attend college, the owner of the account can simply change the beneficiary of the account to another child with no consequences. You can even use the money for yourself if you plan to attend college or graduate school.
Because the account is in your name, you have flexibility and control over how it is spent. In other words, your niece, nephew, or grandchild won’t be able to blow the money on a shiny new sports car! If they want it, they have to use it for their education. The money won’t hurt the child when it comes time to determine how much financial aid they qualify for since it’s not in the child’s name.
The cost of going to college will continue to increase each year for the foreseeable future. Choosing an age-based fund within a low-cost 529 plan is the best way to save for your kid’s college expenses. Just remember to max out your own retirement savings first.
To learn more about 529 plans, a great place to start is SavingForCollege.com.
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