By Laur Davidson, a freelance writer for hire.
If you are parent with aspirations of seeing your child graduate from a four-year college without the burden of student debt, you are no doubt aware of the mushrooming costs of higher education. Not to belabor the point, but it is worth noting that, according to a Bloomberg study, the cost of college tuition and fees have increased nearly 1,300% since 1978. That is more than double the rate of health care costs, which have risen 634% over the same period of time. Meanwhile, the rate of inflation has increased just 279% in that time.
The upward trajectory of college costs is not likely to change anytime soon, which means parents need to take matters into their own hands to provide their future college students with the opportunity to obtain a degree. As reported by LendEDU data, parents are now forced to cosign on 90% of private student debt. As a parent, do you want to save for college today or feel the consequences of student debt later? Fortunately, there are a number of strategies parents can undertake; but, the key is to start sooner rather than later.
Get Time on Your Side
As with any long-term goal, the most important factor in achieving success is time. Time is a valuable asset, but it is also a wasting asset. If you put it to work for you, you can approach any goal like a marathon rather than a spring. Time is what powers the magic of compounding returns, which is the key to achieving any long-term goal. With each month or year that passes before starting a systematic savings plan, the cost of your goal increases, requiring a higher rate of savings or a higher rate of return, or both.
Even if you start your plan with $50 a month, the additional time enables your money to work harder. If the goal of a college education is important enough, you should be able to arrange your spending priorities to allow for your savings amount to grow.
If you are able to invest just $200 a month starting when your child is one-year old and earn an average 6% return, it will grow to more than $70,000 by the time he or she enters college. Increase the savings amount to $300 and you will have a $105,000.
529 College Savings Plan
529 plans were created by Congress to incentivize parents to save more for their children’s college education. Each state operates its own 529 plans, with some states offering more than one plan.
Contribution Limits
The contribution limits are established by each state; but, generally, parents (or anyone who wants to contribute to the plan) cannot contribute any more than $300,000 total to the plan. That includes any plan earnings. So, for example, if total contributions are $250,000 and the plan earns another $50,000, no more contributions may be made to the plan.
Parents or anyone who contributed to a 529 plan should be aware of the gifting rules, limiting annual gifts to $14,000 to be excludable from gift taxes. However, the IRS will allow for an initial contribution of 5 years worth of gifts, or $70,000, which is a nice way of jumpstarting the plan.
Tax Incentives
Contributions are made with after-tax dollars but earnings accumulate tax-deferred. Withdrawals can be taken tax-free if used for eligible college expenses. Funds taken from the plan and not used for qualified expenses will be taxed as ordinary income and a 10% penalty will be applied.
Investment Options
529 plans are set up as investment accounts, with a range of investment options much like a 401(k) plan. Fees and investment performance can vary widely from one plan to the next, so it is important to thoroughly study the plan prospectus and compare plans.
Investment Strategy
Once you find the 529 plan that best suits your needs, choose your investment options, allocating a certain percentage of your monthly contribution to each option depending on your risk profile. Some plans offer an asset allocation tool to help you determine which mix of investments best fit your profile. You should monitor your plan annually to ensure your asset allocation doesn’t stray from your profile. As the time horizon grows shorter, you may want to consider shifting your allocation to a more conservative profile to avoid a market decline within a few years of starting college.
Set it on Auto Pilot
529 plans include an automatic savings feature that allows you set your plan up as a systematic investment program. An automatic, systematic savings plan is a big key to long-term investing. Not only does it ensure money is always going into the plan, it enables you to take advantage of dollar cost averaging (DCA). DCA is an investing strategy that takes advantage of the price changes in the market to accumulate more shares of a mutual fund at a lower cost basis over time. When the market goes down, your monthly savings amount buys more shares; and, when the market goes up it buys fewer shares. As long as the market continues to go up over the long term, your cost basis in the investment will always be lower than the current share price.
