Saving for College: The Lowdown on 529 Accounts

According to CNN Money, student debt in the U.S. now totals $1.2 trillion, which is up 84 percent from 2008 levels. About 40 million Americans have student loan debt, and the average amount of debt is $29,000 per person. Unemployment is high among new graduates with bachelor’s degrees, which makes it even tougher to handle this kind of debt.

Instead of relying on student loans to finance your child’s education, start early by opening up a 529 account or even an education IRA. By investing as little as $25 each month now, you’ll give your child a head start toward paying for college. Also, by reducing your child’s debt load, you’ll ensure that your child isn’t saddled by huge financial burdens after college.

What Is a 529?

529 plans, named after Section 529 of the Internal Revenue Service code, exist in all 50 states and in the District of Columbia. They’re vehicles that allow you to invest the money that you save toward your child’s college costs. In addition to giving you good returns on your investment, they also provide some nifty tax breaks. Instead of socking away money in a savings account, which at today’s rates will earn less than 1 percent interest, you can take advantage of the higher returns that come from investing in securities. Whether your children want to investigate a career in business and earn an MBA or become doctors or fashion designers, you’ll be ensuring that they won’t have to turn their backs on big dreams because they don’t have enough money.

When your child gets ready to go to college and applies for student loans, the 529 account counts as a parental asset. This rule benefits both you and your student because parents are expected to contribute a much smaller percentage of their assets toward college than a student is expected to pay. Also, many states give tax deductions for money contributed to a 529. If you start investing in one state’s 529 plan but you don’t earn good returns, you can roll your money into another state’s plan at no charge. Also, if grandparents want to transfer some of their assets to their grandchildren for estate planning purposes, most 529 plans have no income or contribution limits.

Which States Have the Best Plans?

Most 529 plans vary little from state to state. Follow these rules of thumb when picking the best plan for your child:

• Look at administrative costs. Like mutual funds, 529 plans have administrative costs, and plans that don’t keep costs under control can eat into your returns. Steer clear of plans that have administrative costs of more than 1 percent.
• Examine investment options. Most plans also allow you to invest in a mix of stocks and bonds. Look for age allocation plans, which invest more aggressively when your child is young and more conservatively as he or she approaches college age.
• Know your state’s tax benefits. If your state offers a deduction for your 529 contributions, then that deduction makes it worthwhile to choose your own state’s 529 plan.
• Check for contribution limits. Most plans allow you to contribute as little as $25 or $50 per month, and many have no upper limit on what you can give.

How Do You Sign Up?

You can enroll in 529 plans through a broker, but enrolling on your own will save you from paying unnecessary fees. Simply visit your state’s or another state’s 529 plan site, create an account, choose an investment option, decide how much you want to contribute each month, and link up your bank account.

When you’re struggling to make ends meet, contributing to a 529 might seem unrealistic. However, if you can find just $25 per month now by cutting back on other expenses, your small contribution can grow more than you ever anticipated thanks to the miracle of compound interest. Try this calculator to compute how much you need to save and to see how much even a small monthly contribution can grow over time.

Even if you can’t pay for all of your children’s college costs, thanks to your 529 plan you can make a significant contribution that will decrease their future student loan debt. Best of all, you’ll increase your chances that they won’t end up living back at home with you after graduation.