Parents who start saving for college when their children are newborns will end up with 30 percent of their savings made up of earnings from their investments. Meanwhile, parents who start saving when their kids are in high school will only get 10 percent from earnings.
This shows that when it comes to college savings, parents who make a plan early come out ahead.
Part of that plan is deciding how much you will contribute to your child’s higher education – and how much he will contribute. Another part is calculating how much you can save each month, and another is choosing where to put that money while your child grows.
529 Savings Plans are a common choice. These state-run accounts allow individuals to grow money tax free – and withdraw tax free, if they use the money for higher education expenses. Here are some frequently asked questions about 529 plans and their benefits:
Will the money in my 529 plan affect my child’s eligibility for need-based financial aid?
Yes, but barely. Only up to 5.64 percent of a 529 Plan’s value will be considered in calculations of need-based aid. In other words, you’d have to save about $15k before even $1k gets added to your expected family contribution.
What can the money be used for?
Eligible expenses include tuition, room and board, textbooks and computers. 529 Plans can also pay tuition at a trade or vocational school. These plans can be tricky if you try to withdraw money for other expenses – you’ll owe income tax as well as a 10 percent penalty on earnings. If a child gets a scholarship, however, you can withdraw up to the awarded amount penalty free.
Is there a limit on how much I can save?
There is no annual limit, although aggregate limits across states range from $235,000 to $520,000.
Should I work with a broker to find a 529 Plan?
Generally, no. Plans sold directly to families have lower annual costs and less expensive investment options. (Some investments come with a sales charge between 1 and 5.75 percent.)
Whose name should the account be in?
Put the account in a parent’s name, with the child as beneficiary. If you’re divorced, set up the account in the custodial parent’s name – this shakes out best for financial aid down the line. Try to avoid putting 529 Plans in a grandparent’s name. When they withdraw money, it will be treated as untaxed income and will affect the student’s eligibility for need-based financial aid. 529 Plans in the student or parent’s name, on the other hand, are counted as assets and do not affect financial aid.
How should I allocate my investments?
Most 529 are set up as age-based glide paths. That means as your child gets closer to college, your investments are automatically shifted among stock and bonds funds.
These investments start at a higher risk level and gradually get more conservative as your child grows. Nonetheless, most plans offer conservative, moderate and aggressive investment tracks based on your personal risk tolerance.
Not all plans define risk the same way, however. A plan labeled conservative could have 40 percent of your savings invested in equities – or it could have 80 percent. Be sure to do your research as you search for the best savings plan.
For a personal college savings planning session with a certified financial advisor, call iLearn Academy at 847-834-0791 and ask about our support services for college-bound students.