Parents with a new baby can set up a college fund earlier than they realize by setting up an investment plan created specifically to grow their savings but minimize risk if used for education.
What is a 529 plan?
A 529 investment plan is a simple way to save for education. Participants can open an account, begin contributing and start using the funds as soon as they would like, according to savingforcollege.com. Each plan has different rules on minimums to open and contribute to an account, as seen on the site’s compare by feature tool.
While funds can be used as soon as the account holder would like, BYU student and 529 plan user Reagan Curtis said giving the account more time to grow is always a good idea.
The plans come in two basic forms: college savings or prepaid tuition.
College savings is an investment plan parents can contribute to over time like any regular investment portfolio, but a 529 plan’s earnings are tax-free if used for approved education expenses, according to collegesavings.org.
Investment associate at Wasatch Storage Partners and previous 529 user Parley Vernon said the account holder can choose how risky the portfolio is, and watch it grow over time until it’s time to pay tuition.
A prepaid tuition plan is set up for a specific university, usually a private college. The prepaid tuition can lock in the tuition rate for a specific college or university if the sum initially invested equals the going tuition rate at that school.
Because most parents can’t invest such a large sum up front, the account provides a pro-rated tuition cost if tuition rates greatly increase over 10 years. Investors can also contribute to this plan over time.
As money is added, the future student is continually guaranteed a tuition percentage match for the cost of tuition at the time money is invested, according to Robert Cole, President and CEO of Private College 529 Plan. The money contributed is put in a portfolio set to keep pace with the average tuition increase rate, according to Cole. He explained with this growth, the investor is responsible for the tuition agreed to upon starting the prepaid plan, and the college is on the hook for the remaining cost.
Which plan is best?
That all depends on what investors are looking for, Cole explained. While there are two basic types of plans, there are actually many different variations of each plan available. Different states have their own versions of the college savings plan, some of which come with tax benefits, according to savingforcollege.com.
There is also an option to buy these plans direct-sold or broker-sold. Direct-sold plans are basically set up online through an automated system, while broker-sold plans go through an advisor and usually come with higher fees. The compare by feature tool on savingforcollege.com also provides a calculator to directly compare returns based on data the user manually enters about potential plans they want.
Vernon said it’s important to take into account the fees the different plans incur, which can greatly reduce returns. Cole said Utah has one of the best plans related to fees, and Vernon said that’s why he chose Utah’s plan.
“I think it’s nice to live in this state where they really are trying to help people out with this and charge low fees,” Vernon said. “So, I think it’s important for people to realize how much Utah is helping them out by making one of the best plans there is.”
Where can I learn about all these plans?
A trusted financial advisor can be helpful when seeking more information. Those interested can also check out sites like savingforcollege.com and collegesavings.org for deeper explanations and comparison tools.
Curtis, whose parents opened an account for her in high school, expressed interest in using these sites going forward.
“I wish my parents would have educated me a little bit more. They explained it briefly but at first, I did not really get it,” she said.
So, what counts as an ‘education expense?’
This depends on the plan. Cole said his private college prepaid plan is stricter in that it only covers tuition and mandatory expenses. According to Robert Farrington at thecollegeinvestor.com, the college savings 529 plan covers tuition, room and board, technology items, and books and supplies. Farrington explained that funds taken out of the account for room and board cannot exceed the college’s estimate for the average cost of room and board for their students. Also, things like travel, cell phone bills and health insurance aren’t covered.
What is ‘gifting’?
The 529 plans can be set up by the person who intends to use the funds or by someone who wants to gift the funds.
Account holders might be the student hoping to pay their own way, or the student’s parents hoping to fund the student’s education. Other account holders might be grandparents who choose to create accounts for Christmas presents.
While each account is limited to one beneficiary, each account can have an unlimited number of contributors, according to Cole. Parents, grandparents and students could contribute to one account overtime, getting the most benefit for the future student. In Curtis’ case, she said her parents set up the account, and both she and her parents contributed to it over time.
Cole said that to make it easier for multiple contributors, the account owner can send account links to grandparents, relatives and friends. Those people can contribute to the 529 account without having to set anything up or keep track of the information.
“One of the nice things about all 529 plans is they allow friends and family to gift money,” Cole said. “During the holidays, we will send out notifications to family to sort of encourage (them) to contribute to (kids’) plans. We always say ‘it takes a village.’”
Why is this better than other options to save for college?
Common ways a student can prepare for college outside of a 529 plan include a regular savings account, stock market investment or scholarships. But scholarships, be they for sports or academics, are not always guaranteed. Regular investing can match the type of growth of a 529 plan, but 529 plan earnings are not taxed, Vernon said. If a person’s tax rate is 20 percent, then instead of paying 20 percent every year, they can save that in their 529. Someone saving for 20 years can see a huge difference in how much money has accumulated over time.
“There’s only one advantage, and that’s the tax savings,” Vernon said of 529 plans. “I think back of the envelope I would say you could easily have twice as much money in 20 years just based off tax savings.”
While Vernon said this seems like an obvious way to save, Cole said in his experience, families will often use a regular savings account, believing they are doing the best they can to prepare for their children’s future education.
“I think in general families don’t understand the tax benefits of a 529 plan over a regular savings account,” Cole said. “They think, ‘Well, I’ll just save for college,’ and they are missing out on thousands of dollars that they could end up saving.”