Looking Into 529 Plans for College Savings

529 Plans for College Savings

Last week, I announced that we’re having our first child, and I talked about some of the financial impacts and decisions that we’ll face. We received an incredible amount of valuable feedback and advice, for which my husband and I are both thankful. In a followup comment, Investor Junkie got us thinking about saving for college in a 529 plan. I decided to take him up on his advice and started looking into it.

What is a 529 plan?

A 529 plan, also known as a Qualified Tuition Program (QTP) is a tax-advantaged savings plan. Its nickname comes from the section of the Internal Revenue Code that authorizes it. Contributions to 529 plans are not federally tax deductible, but qualified distributions are, making it a bit like a Roth IRA for education. On top of this, some states offer income tax deductions for contributions for the plans.

As far as qualified expenses go, the money in a 529 plan can be used for tuition, fees, books, supplies, a computer or laptop, and room and board at an accredited vocational, college, or university in the United States.

There are two types of 529s – prepaid plans and savings plans. As the name implies, prepaid plans have you buy at a locked-in tuition price. Savings plans are more like IRAs, where you can choose from different investing options to meet your goals. It’s also worth noting that you can even start a 529 plan for an unborn child by naming someone else as the beneficiary and transferring it to them when they are born.

Each of the two major types of plans has their own pros and cons that you have to weigh for yourself to see what would be right for your family.

Pros of prepaid plans

  • States usually guarantee their own plans
  • Predictable, fixed payments based on child’s age
  • No nasty tuition surprises at the end

Pros of savings plans

  • All qualified expenses are covered
  • Flexibility to go to college anywhere without complications
  • No age limits

Based on the above information, if we decide to go the 529 route I’m leaning more towards opening a savings plan for our child.

Why save for college now?

There are a few reasons why you might want to start saving for college now rather than later than waiting to do so later.

  • Lower annual contributions – I know it may seem crazy to talk about college so early in the game, but you can minimize your monthly obligation if you start sooner rather than later. Giving yourself more time can be a huge asset.
  • Gift tax limits – Even if you’re able to set aside a large sum in a short period, you need to be aware that 529 plan contributions are subject to gift tax limitations. The gift tax exclusion is currently $13k/year, though a “five year election” lets you bunch five years worth of contributions into just a single year.
  • More time to build up enough to cover it all – It’s our hope that our child doesn’t have depend on student loans to pay for his/her education.
  • Rising tuition rates – Even attending a good quality state school can cost a lot of money. As we’ve been seeing locally with UNC’s tuition hikes, we know that that college will be expensive, so we’ll need all the time we can get.

If our child decides for some reason he/she wants to attend a much more expensive school, they’ll be free to do that. We won’t, however, support that particular financial decision, and they will more thank likely have to apply for student loans to cover the costs.

Prioritizing expenses and looking at alternatives

We’re definitely planning on setting aside money for our child’s education expenses in the relatively near future, but right now isn’t an ideal time. While I’m not in Financial Peace University, I do like the order of financial goals that Dave Ramsey encourages. There are some bills, savings, and debts that we’d like to handle before we tackle college savings.

Besides getting our house ready for the new addition, we want to pay off some debts in hopes of improving our monthly cash flow. Hopefully, we’ll be able to re-evaluate our financial situation in the near future so we can get started.

We also want to explore other alternatives before committing to a 529 plan. For example, Coverdell Education Savings Accounts (originally referred to as Educational IRAs) provide another avenue for college savings, and we want to research those sorts of options before making a decision.

For those of you who are ready to start a 529, Nickel has written some wonderful posts on the topic, including the myths associated with 529 plans, some facts about 529 plans and scholarships, and also a list of some of the cheapest plans out there.

Your thoughts on 529 plans

Okay… Now I’m curious to get your thoughts and feedback on this. How many of you have funded a 529 account for your child(ren)? How did you go about selecting your 529 plan? Do you have enough allocated in the account for expected tuition costs? If not, are you going to continue saving, or do you expect your child(ren) to come up with the difference?

10 Responses to “Looking Into 529 Plans for College Savings”

  1. Anonymous

    Hey Michelle,

    9% anualized returns are very aggressive given the volatile markets that we have experienced over the past 12 or so years. I think people has better start to forget the “10%” average annual stock market return number that has been thrown around for decades. It just isnt in the cards anymore.

  2. Anonymous

    Please, everyone!! Run interest analysis on any pre-paid tuition plan before you commit – Texas’s plan “only” returns 5.5% on investment $, when the stock market averages 10%+. That means they (the plan administrators) are much, much more conservative than need be AND/OR they have significant admin costs.

    Running my own calculations of what will be needed for my 4yo to attend state school, I need to consistently contribute $250/month until she’s 18 and make 9% (ROR)on that money which is not that ambitious or aggressive. Texas tells me I need to contribute $550 per month to achieve the same savings goal via their pre-paid tuition option.

    Also, please be aware that as parents, it is our job to guide our kids to making their college choice. They will be 17 – and frankly, I would not ever give a 17yo $80K to $125K to invest on their own without guidance and direction, so why think they can make a college choice (that will cost that much) on their own? Too many people are emotional about “named” colleges – the Harvards, Yales, & the like…but if my DD wants a literature degree to become an English teacher, I am going to steer her towards a state school at $80K versus an Ivy for $250K (today’s dollars). Because like it or not, an English teacher makes no more/less for having a diploma from UT versus one from Stanford, Princeton or Yale.

  3. Anonymous

    My husband and I opened 529 accounts for our twin daughters when they were 6 months old, starting with their baptism gift money. Since then we’ve put 4% of our monthly income into each account (our state plan–Missouri MOST, Vanguard Growth plan). We consider this a fixed expense, like a utility, although of course we can reduce monthly payments if necessary. Two years after opening the plans, our girls each have more college savings than we did by senior year in high school. It’s a good feeling. By our calculations this will only pay for 2 years at the big state university. The girls will need to contribute or take out loans. However, we’ve also refinanced to a 15-year-mortgage, which will be paid off by the girls’ senior year in high school, and we hope that we can make more college contributions then. I do not consider this our entire responsibility, but we’ll do what we can — and we’ll encourage the girls to be prudent in their choice of colleges and majors.

  4. Anonymous

    A 529 plan is a great way to save for a child’s education, but keep in mind that it is not only for the children, as the funds can also be used for adult college education and other related expenses.
    Here’s a thought as well. As a resident of New York State, you are able to fund the plan and take out the funds as soon as they clear the ban – and take a state tax deduction on the current tax return. This is a great ‘loophole’ for those with children already in college. (Note there may be some negative issues here, so talk to your college or tax planner first.)

  5. Anonymous

    I recently looked into various 529 options for my three kids, and landed up selecting the Vanguard (Nevada) 529 plan. It has a wide range of “do-it-yourself” options, in terms of which you can select from a variety of Vanguard funds, or there are pre-set allocations if you prefer something simpler. The main thing is that the fees are very low, and there are the usual excellent Vanguard index funds to choose from.

  6. Anonymous

    We have started a 529 linked to our Upromise account and my Aunt has set up a pre-paid tuition program through Private College 529 plan. How much we cover will depend largely on our individual kids when they reach that point. Because financial aid is dependent on parental income, I am inclined towards making college happen wherever they want to go….but only if they are equally invested. Either in effort or financial contribution or something. I really hope I can figure that out when the time comes.

    Though I do have one 529 plan set up to hold upromise money, I don’t have a solid plan on what to do for the long term. Right now the tuition for the kids daycare is more than our mortgage, but the plan is to save that amount when the kids get out of daycare. But I still can’t decide if I should invest in my retirement first and the kids education second. It’s a hard choice with limited funds!

  7. Anonymous

    @Michelle Laura mentioned it in the post – contributions to a 529 are considered a gift and as such subject to gift tax limits. What this means in practice is that the max is $13k per person per child, or $26k for both parents.

    Less talked about is that there is usually a limit for the max balance (they don’t force you to take money out, but you can’t put any more in once it reaches that balance.) But the balance is so high (last I heard it was $300k) that it shouldn’t impact most people, even at the most expensive schools.

  8. Anonymous

    @Steve, what do you mean “maxed out”? I’m just starting to research for “hope to have” baby in 2012. is there a limit on how much you can contribute in a year?


  9. Anonymous

    We’ve opened a 529 for our 7 month old daughter. We almost maxed it out last year, but I don’t expect that to continue; I wanted to front-load the contributions. I chose the MA Fidelity plan because Fidelity and Vanguard are almost identical on expenses, and I already had accounts at Fidelity. We may end up putting enough in the account to cover any reasonable college, depending on how the next 18 years go.

  10. Anonymous

    We’ve opted to open a 529 account for our 20-month old son. I called in to a local radio show hosted by a financial planner in the area, he explained that my state offers no tax incentives for using our state 529 plan. He recommended Utah’s 529 plan for their low costs and Vanguard funds.

    Our plan of attack is to put in $3000 per year, with a portfolio focused on aggressive growth at first. Later, we’ll begin making more conservative investments for him.

    We figure that this should give him enough money for a full four years at a state school or for two years at a private or out-of-state school. It will be his decision whether he wants to go into debt for school or not.

    We have another child on the way and will do the exact same for him as well. I think it will be interesting to watch my children grow and see what they decide to do with the college savings we have put away for them.

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