Photo by Larry Crayton on Unsplash, https://www.faams.org/early-childhood-focus-groups-theres-still-time-to-give-your-input/larry-crayton-oj77q2yijzi-unsplash/
Uché Perkins, who tweets under the handle @JustAFamilyMan_ , reached out to his 3,247 followers and urged them to please open up a 529 college savings plan as soon as possible if they have children.
“It does not matter if you contribute $25 a month or $100 a month. Your children will thank you later, because of the magic of compound interest,” wrote Perkins, who identifies as a husband, #GirlDad x 2, Black American & Igbo, and alumnus of the University of Maryland Francis King Carey School of Law.
Many parents are familiar with 529 college saving plans but don’t fully use the program, according to Michael Aloi, a wealth management advisor at Summit Financial, LLC.
Here are five things to know about the science and benefits of opening a 529 college savings plan for children.
The average cost of public in-state college tuition, fees, room and board in 2020-21 is $26,820 a year and $54,880 for a four-year private college, according to a recent study by the College Board. For a child born today, the annual cost of college is expected to more than double to $57,517 for public college and reach $131.657 a year for private college, according to a recent study by J.P. Morgan.
Perkins shared an outline of his college saving plan for his daughters. He wrote that he contributes $100 per month to each daughter’s 529 plan through the state of Maryland and T. Rowe Price.
“I picked an index fund that tracks the S&P 500,” Perkins wrote. “And I opened it up for both of them as soon as they were born. At a 10% ROI, in 18 years they should each have $58k.”
A 529 college savings plan is a state-sponsored investment plan that enables you to save money for a beneficiary and pay for education expenses. You can withdraw funds tax-free to cover nearly any type of college expense and 529 plans may offer other state or federal tax benefits.
Contributions are after-tax — there is no federal tax-deduction up-front for 529 plans. Earnings grow tax-deferred, and withdrawals for qualified higher-education expenses (room, board, tuition and some fees) are income-tax-free, Aloi wrote in a Kiplinger report.
In addition, assets in a 529 plan get preferential financial aid treatment when owned by a parent. A maximum of 5.64 percent of parental assets count toward a family’s Expected Family Contribution (EFC) when applying for federal financial aid, versus 20 percent of a student’s assets, according to Savingforcollege.com, Aloi wrote.
The cons? There’s a 10-percent penalty on withdrawals for not using 529 money for college, and the earnings are income taxable.
There are several ways to make monthly contributions to a 529 plan, according to Vanguard. These include an age-based mutual fund, building your own fund, or bonds.
Age-based options are all-in-one portfolios that help you invest for college with a specific target date. The assets shift from riskier investments to more conservative bonds as your child gets older and closer to the first year of college.
“This makes sense, as you want 529 money to be conservative as the child gets closer to withdrawing the money for college,” Aloi wrote for Kiplinger. “Age-based funds are set-it-and-forget choices, meaning busy parents don’t have to manage the investments themselves.”
Or you can build your own 529 portfolio and invest in index funds as a part of it. For children more than five to seven years away from college, parents may want to consider an all-equity portfolio to maximize growth, Aloi wrote.
Forbes recently reported that the cost of attending college rose more than twice as fast as inflation. For example, between 1985 and 2018, college costs rose 497 percent. “Good luck beating that inflation rate with low-yielding bonds,” Aloi wrote. “If interest rates rise, bond prices may fall, making bonds by some measures riskier than stocks.”
“Inflation is the real risk to a newborn, not a stock market correction when the child is 5 years old,” Aloi wrote. “Not only that, but if interest rates rise, bond prices may fall, making bonds by some measures riskier than stocks.”
Aloi recommends starting by reviewing your home state’s 529 plan vs. an out-of-state 529. Does your state offer a tax break for contributions to its 529 plan? How do the fees compare for your tate’s 529 versus another state’s plan? You can use a 529 plan in other states. Some, including California and New Jersey, offer no state tax break for contributions.
“Either way, you should compare the fees and mutual fund options in your state’s plan versus an out-of-state 529,” Aloi wrote. “Just because a state offers a state tax deduction for your contributions doesn’t make it a ‘good plan.’ Besides, the state tax deduction doesn’t usually amount to much either. Other states’ 529 plans may offer lesser fees or better mutual fund selection.”
Perkins @JustAFamilyMan_ wrote, “If your state does not have its own 529 Plan, Fidelity does offer such services. I personally prefer to use index funds to track the S&P 500 because they have a better track record.”
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