For the past 30 years, the price of sending a child to college has risen faster than the rate of inflation. The average undergraduate at a four-year private college paid $23,712 in tuition and fees in the 2007-2008 academic year, up 6.3% from the year before, according to the College Board. Meanwhile, consumer prices rose 2.9%.
Saving money for college is hard enough, and sharp increases in these costs only add to a family's burden. If tuition and fees continue to rise at just 5% a year, they'll reach $38,600 a year in 2018. How can families keep up?
This is where 529 college savings plans come in. Millions of Americans are using these plans to supercharge their college savings.
What is a 529 College Savings Plan?
Put simply, these accounts shelter education savings from federal taxes, and sometimes state taxes. Contributions to 529 accounts, as well as any investment earnings, can be withdrawn free of federal taxes to pay for qualified expenses at eligible schools.
The plans saved taxpayers $690 million in federal income taxes in 2006, according to the US Office of Management and Budget. In five states, contributions to an in-state 529 plan are tax deductible. There were more than 10 million 529 college savings accounts in 2007, with an average balance of more than $12,000.
Are There Other Kinds of 529 Savings Plans?
There are two flavors of 529 accounts, which are named for the federal tax code that gives preferential tax treatment to college savings. Of the two plans, 529 college savings plans are by far more popular. Of $122 billion held in state-sponsored 529 plans, 86% was held in college savings accounts. The remainder was held in 529 prepaid tuition plans, which are more restrictive.
Prepaid tuition plans allow a family to buy future tuition at the current price, but only at an eligible in-state school. Many families prefer the flexibility of the 529 college savings account.
Who Can Open a 529 College Savings Account?
Almost anyone can open a 529 account on behalf of a future student. The student can be a child, a relative or even a friend. You can even open a 529 account on your own behalf, if you're planning to go back to school. The government allows the money to be spent at virtually all accredited post-secondary schools in the country, and even at some schools abroad. There are no income limits for these plans, and most states allow contributions of more than $200,000 per student.
What Can a 529 Savings Plan be Applied Toward?
- Tuition and school fees
- Room and board
- School supplies and equipment, such as books
What are the Investment Options in a 529 Savings Plan?
States offer their own 529 plans with different fees and investments, usually mutual funds. Some plans can be opened directly with the state; others can be purchased through an adviser. The most popular investment choices are age-based allocation funds, which make picking investments as easy as calculating how many years until school begins.
These funds use a mix of investments, including stocks and bonds, and they become more conservative as the target date arrives. Plan choices may also include stock funds, bond funds and stable-value funds. Some also offer options that are FDIC-insured like bank accounts.
What Does a 529 Plan Cost?
Fees eat away at 529 account balances, and this is one of the most important factors to consider when choosing a plan. Fees come in many shapes and sizes, but overall they have been falling rapidly, according to Morningstar, a mutual fund rating firm. Because fees vary by plan, it's often beneficial to consider an out-of-state plan. Typical fees include:
- Plan enrollment fee
- Annual plan maintenance charge
- Sales charges when mutual funds are bought and sold-these charges are also known as "loads"
- Plan administration fee, for the cost of managing the plan
- Fund expenses, which are taken out of the fund's investment returns
Shopping Around
Morningstar ranked these 529 college savings plans as the best in 2008:- Illinois: Bright Start College Savings
- Maryland: College Investment Plan
- Virginia: CollegeAmerica
- Virginia: Education Savings Trust
- Colorado: Scholars Choice College Savings Program
Will Having a 529 Savings Plan Reduce My Child's Financial Aid Package?
Yes, but not as much as you might think. If a parent owns a 529 plan for the benefit of a child, only 5.6% of the account value is used to determine the amount the family will be expected to pay toward higher education. That's far less than some alternatives to 529 plans, such as custodial accounts held in the name of the student. With those accounts, 35% of the account value is counted when determining the expected family contribution.
Considering Alternatives
While a 529 plan offers appealing tax benefits, it is only one of several college savings strategies. Families that can meet income limits are eligible to contribute to a Coverdell education savings account, which offers nearly unlimited investment choices. Custodial accounts and education savings bonds are other popular alternatives.
Further Resources
To learn more about 529 college savings plans, look into:
- The College Savings Plan Network
- The Financial Industry Regulatory Authority's publication Smart Savings for College
- The Internal Revenue Service's publication Tax Benefits for Education
- Morningstar's list of the best and worst 529 college savings plans
