Money in the Media #16

Average Start for 529 College Savings (Age 7) Is Costly, Study Finds

I’ve been talking a lot about costs of college and post highschool education lately. To round out everything that we’ve discussed, I wanted to pull in a conversation about how parents can help their kids pay for their post highschool education. So, today we’re taking a look at a New York Times article entitled “Average Start for 529 College Savings (Age 7) Is Costly, Study Finds.”

What’s a 529?

Before we jump into this, I just want to review what 529 savings plans even are for those who may not know. Similar to 401K/403/457, etc, 529 is named for the section of the tax code that defines the plan. This type of savings plan allows families to save for their child’s future education costs.

While the money contributed to the 529 plan is not tax deductible, the investments earned within the plan can grow tax free and withdrawals made for eligible expenses are also tax free. Eligible expenses can be tuition, books, housing, meal plans and necessary school equipment needed for your child’s education. Additionally, as of 2018, the eligible expenses have been expanded to include private school tuition for up to $10,000 starting with elementary school.

Plans are offered at the state level and are run slightly differently, depending on the state laws and plan management company. There can be tax benefits by contributing to your state’s specific plan, but you DO NOT have to use the plan for the state you live in. You can pick any state’s plan. For example, if you live in North Carolina and there is no benefit to contributing to the NC plan, maybe you would prefer the Massachusetts plan for lower fees.

Each state’s plan can be found here, along with a comparison of state benefits and minimum contributions.

Age Based Investing

You may be familiar with the concept of age based investing from your retirement plan. Many retirement plans have the option for a target based investment fund. This is the same concept as the age based investing for many 529 plans.

When the child is younger and farther from the age when withdrawals would need to be made, more of the investments are put into equities (stocks) and less into bonds for a more aggressive portfolio. As the child ages, the portfolio will automatically re-balance to hold more bonds to move towards a more conservative portfolio.

Why Is That Bad?

Normally, this would not be a bad thing, but taking a look at when the average 529 plan is opened tells a different story.

Many parents wait until age 7 to open up a 529 savings plan for their child. By this time, the age based portfolio has already dropped from an 83% stock allocation to a 67% stock allocation, lowering the expected returns for that portfolio. On top of this, those first 7 years of compound interest are crucial to increasing the overall funds available in the account.

Depositing $200/month from birth could yield $73,300, but waiting until age 7 could lower that amount to just $36,000, or less than half.

In order to make up the difference, parents would have to save an additional $200/month for the last 11 years. Having to double the college savings amount could put significant strain on a family’s finances. As a result, many do not take that extra step and just save what they can to help. However, that causes another problem:

The average published cost of tuition, housing and meals is about $22,000 a year for in-state students at public four-year colleges, and about $50,000 for private, nonprofit four-year colleges, according to the College Board.

These costs will unfortunately rise over time; by how much is up for debate. However, it is indisputable that college savings can give students a leg up in relation to loans, stress and potential quality of life as a student.

Why Wait?

Many parents wait to open a 529 plan simply because they are unaware of them. Other than that, they may not be able to save as much with a new child in the home. On that front, gifts from friends and family can help and sites like Gift of College are setting up the infrastructure to make this happen.

So, if you have young children, I would highly recommend opening an account for them early on in order to take advantage of the longest time horizon possible to when the funds would be needed. I will, however, put one caveat out there:

Do not prioritize your child’s college fund over your retirement!

There are many reasons for this that warrant their own post, but for now I will leave it at this. Your child has a much longer timeline to recover from student debt than you will have to recover your retirement accounts if you prioritize their college savings.

What To Do?

The best thing to do is to save as much as possible and as early as possible towards your child’s education without negatively impacting your retirement.

Giving students a leg up on education costs is an important way to give them a great start in life. Saving in a 529 makes this easier, but to take advantage of everything these plans have to offer, they should be set up as soon as possible after birth.

Do you have a 529 plan for your child’s future education costs? Did your parents save for your education costs? How did this impact your loan needs and life after school? Let me know in the comments below!

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