Money invested the year the child was born is worth two to three times as much as money invested when the child enters high school. —Mark Kantrowitz, Edvisors.com
Young parents can hear shocking statistics — such as that some private schools could cost about $450,000 for four years by the time today’s newborn heads to college — and give up on saving any money.
It’s overwhelming to consider that cost of college has tripled in roughly 18 years.
But giving up means you’re throwing away the chance to accumulate a respectable stash of cash.
Every dollar can count if your child goes to a private school or state college. About 17 percent of families used 529 plans to pay for college in 2014-15 school year, up from 15 percent the year before, according to the newly released, “2015 How America Pays for College,” published by Sallie Mae and Ipsos.
The average amount used from a 529 plan was $9,129 in the 2014-15 school year vs. $9,233 for the earlier year. Back in the 2012 study, only 11 percent of families used 529 plans to pay for college, and the average amount used was $6,616.
No doubt, 529 savings alone won’t foot the entire bill. But savings could play a part — along with summer jobs, scholarships and keeping an eye on college costs — in clamping down on student borrowing.
Here are three key things to know about 529 savings plans:
Grandparents can play a part and contribute to 529 plans. But they need to watch how they do so
Mark Kantrowitz, a college debt expert and senior vice president and publisher for Edvisors.com, said ideally grandparents should save money in a 529 plan that is owned by the parents.
The reason? The student’s eligibility for financial aid could be improved if the money is in a parent-owned plan and not in a 529 plan owned by the grandparent.
A parent-owned 529 plan is reported as a parent asset on the Free Application for Federal Student Aid, or FAFSA. But Kantrowitz noted that distributions are not counted as income to the beneficiary in the case of a parent-owned plan.
On the other hand, if the 529 is owned by the grandparents, the 529 is not reported as an asset on the FAFSA, but in this case distributions are counted as untaxed income to the beneficiary on the subsequent year’s FAFSA.
“This can reduce the eligibility for need-based financial aid by as much as 50 percent of the distribution amount,” Kantrowitz said.
If grandparents have already set up 529 plans, they can wait until after the FAFSA is filed and transfer the amount of the distribution from the grandparent-owned 529 plan to the parent-owned 529 plan, Kantrowitz said.
Another workaround: Wait until the student’s senior year in college to tap into money in 529 plan owned by the grandparent, especially if the student is graduating and not going on to graduate school immediately, Kantrowitz said.
All 529 plans are not the same, so it can pay to study up
Dozens of 529 plans exist with each state offering one or more 529 plans. Some are sold through financial advisers; others can be bought directly by the saver.
Morningstar calculates rankings by examining factors such as performance, price and the people managing the plan.
Morningstar gave its highest gold ratings to Arkansas’ T. Rowe Price College Savings Plan, the Maryland College Investment Plan, Nevada’s Vanguard 529 College Savings Plan, and the Utah Educational Savings Plan.
Leo Acheson, an analyst at Morningstar.com, warned that about half of the 529 plans charge annual maintenance fees that could cut into savings. Others don’t.
Paying an average of $19 a year or as much as $30 a year for such a fee adds up. So if possible, you might want to avoid plans with maintenance fees or figure out how to get those fees waived.
There’s no tax break on your federal income tax return when you put money into 529s, but residents of some states could receive a state tax break on their contributions to certain plans.
In Michigan, for example, contributions to the Michigan Education Savings Program offer a valuable tax break on the Michigan state return for Michigan residents, said Joseph Hurley, who founded SavingforCollege.com.
Michigan taxpayers may be eligible for state income tax deduction on contributions to the MESP of up to $10,000 for married couples filing jointly each calendar year. The calendar-year limit is $5,000 for individuals filing single.
The Michigan Education Savings Program ranks among the top of Morningstar’s list with a “silver” rating. It only takes $25 to open the MESP. But the minimum contributions can be as low as $15 if you set up a regular payroll deduction plan from paychecks.
The MESP plan, which started in December 2000, is managed by TIAA-CREF Tuition Financing Inc. The average MESP account is $19,261.
Michigan also has a prepaid tuition program called the Michigan Education Trust.
Investing some money for college when a child is young can pay off
Kantrowitz notes that when a parent starts saving the year the child is born, making equal monthly contributions, it’s possible that about a third of the college savings goal will come from earnings.
But if the parent waits until the child enters high school, actual earnings from investments will contribute less than 10 percent of the college savings goal.
“In effect, money invested the year the child was born is worth two to three times as much as money invested when the child enters high school,” Kantrowitz said.
In general, money in a 529 plan can be used to pay for college tuition, books, room and board and other required expenses. Under the current rules, if money taken out of a 529 plan is used to pay for qualified higher education expenses, the earnings on the 529 savings would be free in general from federal and state personal income taxes.
But some states can have unique rules. Illinois, for example, only allows for an exemption for withdrawals from an Illinois plan or from other plans that adopt certain disclosure and notice requirements, according to Rocky Mengle, senior state income tax analyst for Wolters Kluwer Tax & Accounting US. And he noted that Alabama does not allow an exemption for withdrawals from a non-Alabama plan.
The tax rules on 529 plans can be complex, so it pays to do research there as well.
About the writer
Susan Tompor is the personal finance columnist for the Detroit Free Press. She can be reached at [email protected].
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