How Can You Effectively Plan for the Increasing Cost of College Education?
For many parents, planning for their children’s college education is their second most important financial goal, behind planning for their own retirement. Over the past five years, the total cost of tuition and fees at a public four-year university has increased by an average of 3.2% per year. While tuition is the largest single component of the cost of education, there are other components to consider when planning for a child’s education expense such as room and board, fees, supplies, and travel. The total cost of a college education can become overwhelming if you do not begin planning and saving early.
One of the most effective strategies to begin planning and saving early is the use of a 529 Plan. Sponsored by a state or state agency, savings can be used for tuition, books, and other education-related expenses at any public or private qualified school in any state, regardless of your state of residence. These savings plans have several key incentives:
- Investment earnings are not subject to federal tax when withdrawn for use on qualified education expenses and may also be eligible for state tax deductions. Two-thirds of states give residents a tax deduction or a tax break based on the contribution.
- A 529 plan held in a dependent student’s or parent’s name will not count as an asset of the student should he or she apply for financial aid. The 529 plan will be treated as a parental asset which may reduce need-based aid by a maximum of 5.64% of the 529 plan’s value. This is quite favorable as compared to other student assets, which could reduce need-based aid by 20% of the asset value.
- The balances in a 529 plan can be transferred between family member beneficiaries, so if one child does not use the funds in their plan, the remainder can be transferred to a sibling tax-free.
According to a Sallie Mae study, families tend to save more money once they have a 529 college savings plan in place. You can open a plan with as little as $50 and create an automatic monthly contribution, or you can combine up to five times the annual $14,000 gift tax exclusion to make a one-time gift of up to $70,000 to jump-start a college account. This can be an effective estate planning tool for wealthy grandparents, as no gift tax is involved. You can contribute extra money to the plan at any time and invite friends and family to make gift contributions.
Once a 529 plan has been established, the next question is often “how much do I save?” Fidelity Investments recommends using the “2K rule of thumb” to save for your children’s education. To use this strategy, multiply your child’s age by $2,000. This approximates the amount you would want in the child’s 529 plan to cover $10,000 of college costs per year for four years. The savings target grows as a child grows older and can be adjusted based on a family’s individual circumstances. With the historical 10-year average rate of return of a 529 plan ranging from 4%-6%, starting early with this strategy and making periodic contributions can help build significant savings and prepare you to handle the cost of an education when the time comes.
Bottom Line
The cost of an education has continued to dramatically increase and can be an overwhelming expense if you do not begin to plan and save early. One effective way to do so can be opening and funding a 529 plan to take advantage of potential tax savings and favorable financial aid treatment. The guidance and support of a financial counseling team can help you to customize a savings plan in line with your unique circumstances in order to reach your financial goals.