Everybody knows that their children's college tuition is going to have to be paid somehow by someone someday.
Starting to save for college seems like a daunting task to many parents of young children. First, the fact that college is so far into the future makes parents feel like there is plenty of time left to start (hint: there isn't). Second - and by far the most impactful - is the uncertainty of how much college is actually going to cost once your child starts college.
Higher education costs at both 2- and 4-year colleges and universities have been rising steadily over the last decade. These 10-year higher education inflation numbers vary by state. For example, Louisiana has had to deal with the worst increase of 106.9% while Ohio's comes in at a much more reasonable 5.2%.
In fact, nationwide in 2017 the average cost for one year of education at a 4-year college in the United States clocked in at $9,725. By 2027 that figure is expected to be almost $12,500!
Parents of college-bound children are going to have to help pay for these rising costs somehow. These costs include tuition, fees and living expenses. Many families are putting their hope into scholarships and federal grants like the Pell Grant, but those grants have not been growing at the same rate as the costs to send your child to college.
Fortunately, there are many options available to those looking to save for that college degree. Some of the options available include savings bonds, playing the stock market and the lesser-known 529 plans. A recent 2018 study by Edward Jones found that only 29% of Americans were even aware that 529 savings plans existed.
529 Plans grow in a tax-free environment (i.e. you do not pay taxes on any growth), and generally have a 3-5% rate of return.
Starting a 529 account now is always the best option, no matter how old your child is. While utilizing the stock market may potentially yield higher returns on your initial investment, placing your money into a 529 plan is usually the safest option to pay for higher education. This is because while a 529 account grows in a tax-free environment, many states also allow parents to apply immediate tax deductions on the money put into these accounts. One study even found that when the all the various tax benefits were taken into consideration, 529 plans outperformed their benchmarks in every category.
Every US state except Wyoming has their own state sanctioned 529 plan available to their constituents. Usually with an initial contribution of less than $100, you can begin saving for your child's education in any of these state-managed 529 plans. We have reports for each state that give you details on each of their 529 plans. In addition to these plans, many financial companies such as Charles Schwab, Vanguard and TIAA-CREF have their own versions of a 529 account. The only difference between the two types are where the fees are paid. Overall, they are similar enough to just pick one you are comfortable with and start saving immediately.
The largest caveat of 529 plans is the fact that you can only use the funds inside these accounts on eligible education expenses. However, not all college expenses are covered. Here is a list of all qualified expenses you can pay with a 529 Plan:
Unfortunately, not all college expenses are allowed to be paid for with a 529 savings account.
A major concern for anyone considering investing in a 529 Plan is what happens if your child does not go on to higher education after high school. While there is a 10% penalty for any non-qualified withdrawals, there are some creative ways to get around this restriction.
You won't be hit with the 10% penalty if your child receives a scholarship, dies or enrolls in a US service academy instead. While you'll still have to pay income taxes on any gains earned in these circumstances unless you pay for a qualified expense, it is still a favorable outcome.
If you have multiple children, you can also change the beneficiary of any 529 plan if one gets a scholarship or another exemption occurs. This means that if you are not in need of the money, you can always let it sit and gift it to another family member like a grandchild.
You can also withdraw the amount of principal that you invested without penalty. This means that you can leave the growth in place to avoid being penalized.