If you're worried about how you will fund your child's college education, you're in good company. According to a national survey from Discover® Student Loans, 70% of parents with college-bound children are concerned they won't be able to cover the cost of their child's education. Taking the first step to understand your options is the best way to regain your confidence and ensure your savings work as hard as you do.
Why 529s matter for your family
529 college savings plans are a powerful tool to help ease the burden of future college costs. These accounts are enticing because they offer tax advantages, potential returns, and can significantly reduce the need for student loans later on.
However, figuring out which one fits your life can feel overwhelming. That might explain why, according to Discover® Student Loans, only 33% of families used a college savings program to cover their qualified education expenses in 2022.
What to consider when picking a plan
Forty-nine states and the District of Columbia sponsor a 529 plan. Currently, Wyoming is the only state that does not offer a plan.
The good news is that you can choose from most states' plans, not just the one where you live. While having choices is wonderful, it can make the decision a bit tricky. When you're selecting an account, it's important to consider factors like where you live, your risk tolerance, and your time horizon. Ultimately, your goal is to optimize your college funds so they work to your maximum benefit.
Understanding the fees
All 529s charge fees, but these vary from state to state. Here are the most common costs you should know about:
- Enrollment and annual maintenance fees: This is a low annual charge for setting up and keeping the account. It is typically less than $50 for each.
- Expense ratios: This is the percentage of your funds that pays for the cost of owning the underlying assets. Accounts opened with financial advisors or brokerages (advisor-sold plans) are typically more expensive than those opened directly (direct-sold plans).
- Sales loads: Accounts opened through brokers may charge a commission on a percentage of your investment. Direct-sold 529s do not charge sales loads. Be sure to check your provider's official source to learn more about sales loads.
Investment options and tax perks
The range of investments available is another huge factor. While some options offer only a handful of choices, others may offer dozens of mutual funds and ETFs. In general, it's best to select an account with more options to ensure you have the flexibility to manage your college savings portfolio effectively. Also, consider each fund's performance over time and compare it against other options.
The tax benefits
The tax treatment for 529s is similar to that of a Roth IRA. Your after-tax contributions enjoy tax-free growth, and that money can go toward qualified educational expenses tax-free. Many states also offer tax credits or deductions on contributions.
State tax deductions vary, so it's vital to check what your specific state offers. Currently, nine states provide a tax break for contributions made to any state's 529 plan. There are also nine non-income tax states that do not offer a tax break, and four that levy a state income tax but do not offer a state tax deduction. Always consult a primary source or tax professional for the most current state-by-state breakdown.
Prepaid tuition vs. education savings
Generally, 529 plans fall into two categories: prepaid tuition plans or education savings plans.
Prepaid tuition plans allow you to lock in today's tuition rates and pay for future college expenses. They offer a fixed rate of return, which is typically lower than the potential gains from investing.
Education savings plans are more like traditional investments, allowing you to invest your money in mutual funds and ETFs so it can grow over time. This approach offers the potential for higher long-term gains compared to prepaid tuition.
Tips for managing your college savings
Since these are long-term investments, managing them effectively is key. Here are some tips to help you get the most out of your savings:
- Focus on low costs: Invest in low-cost index funds or ETFs with low expense ratios.
- Rebalance regularly: Make sure your portfolio is properly diversified so your risk is spread evenly across your investment options.
- Don't be too conservative: While caution is good, investing too conservatively can put your college savings at risk of not keeping up with inflation.
- Automate it: Setting up an automatic contribution is a great way to ensure you consistently contribute to your savings.
- Stay updated: Tax treatment of 529s changes frequently, so keep an eye on changing tax laws that could affect your strategy.
The Facet difference
At Facet, we believe your financial life is about more than just investment returns or saving for a single goal. It's about how all the pieces of your life fit together. You'll work with a CFP® professional to build a dynamic planning journey that adapts as your life changes. Our flat-fee membership model means we never charge commissions, so our advice is focused on what matters most to you.
