By Lawrence Sprung, CFP®
Qualified tuition plans, also known as 529 plans, were created under the the Small Business Job Protection Act of 1996. This type of account gives taxpayers a tax-advantaged way to save for higher education expenses allocated to a designated beneficiary. Even after 22 years of existence, most people know nothing about 529 plans.
Lack of Awareness
According to a recent survey by Edward Jones, only 29% of Americans are even aware that 529 plans are available as an education savings vehicle. One would think this is a scary statistic, but even more frightening is that only 13% of families used 529 plans in 2016-2017, according to a 2017 Sallie Mae report. This is quite a staggering statistic, considering the rising debt being incurred by college students. (For related reading, see: Tax-Smart Ways to Help Your Kids/Grandkids Pay for College.)
When you consider the enormous costs of sending your children to college, which according to the College Board is $46,950 for the average private four-year school, you would think that more people would be using all tools available to them to save for college. The 529 savings account can be an excellent tool to begin to save for this lofty expense. The monies saved for your respective beneficiary grows tax free as long as you use it for higher education.
Keep in mind that the recently passed Tax Cuts and Jobs Act has added provisions that may allow you to also use these funds for K-12 expenses. You will want to check with your individual state, as your 529 plan may not follow the new tax law.
Balancing College and Retirement Savings
There is a struggle for most people to balance saving for college and retirement at the same time. This is a fine balance that needs the attention of proper planning. Although you will not be able to borrow money for retirement, you will be able to do so for college, and you will want to have a plan in place to address both. Not having money in place for your children’s education may have an impact on your retirement down the road but at the same time, overfunding college savings at the expense of your retirement accounts will do the same. (For related reading, see: How 529 Plans Impact Financial Aid.)
The key is to have a strategy in place that will allow you to save for both. You will often hear that you should start saving for retirement early. The same logic applies for education. The more money you save for college early on, the less money you will have to contribute later because you will benefit from the concept of compounding.
Putting a Plan in Place
It is important to have an idea as to how you plan to assist your child and their future education, even if it is 18 or more years in the future. There is no rule when it comes to how much a family is willing to help their children obtain their education. Some intend to pay for their child’s entire education regardless of cost, while others are willing to contribute a certain amount.
Once you have your targeted contribution determined, it is important to develop a savings strategy to get you there because most people cannot simply rely on paying for their child’s education from their household cash flow. You will want to take into account realistic growth and inflation expectations when determining what you will need to save each year for your goal.
If you start working after leaving school and start funding your retirement right away, you may be in a position to lower your retirement contributions when you have children. This will allow you to allocate the previous retirement savings towards your child’s education goal. Depending on how many children you have and what your goals are for supporting their education, you may be able to shift this strategy back by the time your child is 10 years old. Having an 18-year-old child with nothing allocated for college education will, in most cases, place a strain on your financial situation or that of your child, if they need to pay their own way through school.
529 plans can be a vital tool in your education funding savings strategy. I think it is disheartening that this tool is not well known and very much underused. Make sure you do your research early and start using this tool early if you feel it is right for you. (For related reading, see: Why You Should Front Load Your 529 Plan.)
Disclaimer: This article represents the opinion of Mitlin Financial Inc. It should not be construed as providing investment, legal and/or tax advice.
This article was originally published on Investopedia.