As you watch your toddler read her first book, upside down, thoughts of her freshman year in college may seem hazy. But the sooner you start socking away funds, the better your chances of getting her there. It will cost about $440,000 to send a baby born today to a four-year private college. The tab for a state school is about half that amount.
Though the horizon is distant, when it comes to saving for higher education, time is of the essence: The sooner you get cracking, the lower your monthly payments. For example, a high school senior’s parents who started saving when their child was born eighteen years ago would’ve had to save about $245 a month to cover current college costs, according to research from mutual funds provider Fidelity Investments. If they waited until the child was ten years old, that figure more than triples to $915 a month. “Parents really need to begin saving early and regularly,” says Carolyn Clancy, executive vice president at Fidelity’s Personal and Workplace
Investing Group. Where to start? Plain vanilla savings accounts generally aren’t the answer, because they pay low interest rates and withdrawals are taxed. Here, instead, are better bets.
529 Plans
What are they? Probably the most popular college savings vehicles, these state-sponsored programs allow money to grow tax-free. Plus, withdrawals are exempt from federal taxes (and state taxes in some states) as long as the money goes to qualified educational expenses such as tuition, books and room and board. A stash of $300 a month can turn into $115,000 in seventeen years.
Pros
Minimum monthly investments are low ($25), and maximum yearly contributions are high ($12,000 for individuals or $24,000 for married couples). If you get a late start, you can make a special lump-sum contribution of up to $60,000 ($120,000 for married couples) to a child’s account without gift or estate tax implications.
“The 529 plans provide the most benefits in terms of tax advantages and parental control over the assets,” says René Kim, senior vice president at financial services company Charles Schwab, who oversees the company’s retirement and education products.
Consistent annual contributions begun early should pay impressive dividends over time. “A 529 offers a big advantage because of compounding,” says Mark Glea-son, senior financial advisor at Wescap Management Group in Burbank, CA. Investment earnings are added to the principal each year, and the continuous compounding of these earnings quickens the growth and value of the 529. “For parents with young children,” adds Gleason, “compounding can go on for a long time, resulting in a truly large college fund.”
Plus, one of the plans’ best features is “age-based” portfolios: They automatically shift from higher-risk, higher-return stocks into lower-risk, lower-return bonds to protect the assets as your child gets closer to college age. This autopilot approach means less investment guesswork for parents who have children in different age groups, says Kim. It’s also the option that most investors are choosing, according to Saving for College.
Cons
A problem with 529s is that there are about 100 separate state plans—thirty-six states offer more than one 529 program (Nebraska alone has five plans; Arizona has three). While each program offers stock, money market and bond funds, and they’re administered by financial services companies such as Fidelity, Vanguard, and T. Rowe Price, not all plans are created equal.
Key things to consider when deciding if these plans are right for your family include whether your state taxes withdrawals or allows tax deductions for contributions. You also want to find a low-cost program (plan costs vary from about .25 percent to more than 2.5 percent). And look for investment flexibility so that you can choose what best suits your style and goals. Since most plans are open to out-of-staters and are good at most postsecondary schools in the country, it really pays to shop around outside of your own state.
