Let’s face it, the thought of affordable college (public or private) is becoming a fading dream. Even though President Obama recently signed a new student loan bill lowering interest rates to 3.4 percent on subsidized and unsubsidized loans for this year, it does not guarantee that rates won’t rise as high as 8.25 percent for undergraduates, 9.5 percent for graduate students, or close to 10 percent for parents.
Although the Congressional Budget Office estimates rates won’t get that high in the next ten year, what happens afterwards is a mystery. Also, the bill doesn’t prevent another President from signing a bill with higher interest rates later in our lifetime. With the uncertainty of rates and the rising cost of college tuition, now is the time to start planning for your child’s future. You don’t even have to currently have children now to do it. The state-sponsored 529 Savings Plans have changed the way parents are saving. Here are some questions to think about before starting the savings process.
1. What is a 529 Saving Plan?
According to the US Securities and Exchange Commission: “A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.”
The 529 plans have two main types: pre-paid tuition plans and college savings plans.
2. Does my state sponsor a 529 plan?
Although the US Securities and Exchange Commission website states all 50 states and the District of Columbia sponsor at least one type, that is not the case. Wyoming discontinued its 529 plan in 2006; however, you can open a plan in mostly any state regardless of residency since the plan will cover cost for in-state and out-of-state tuition for your child.
3. Are all 529 Plans are created equal?
Unfortunately they are not. Since these are state-sponsored plans, each state has its own specific guidelines. The good thing is you can compare plans between states and types on www.collegesavings.com.
4. If I don’t have kids, do I have to wait to start a plan?
Nope! You can start the plan in your name and once your bundle of joy gets here you can transfer the account to their name fee free.
5. You said the word fee, what kind of fees can I accrue?
Think of 529 saving plans as mutual funds. A percentage of what you contribute is charged an operating fee, annual fee, and other costs to keep your plan in motion. Plans are sold predominantly directly through the state or through investment advisers. The Financial Research Corporation states that a 529 plan through a state averages .69 percent annually and a 529 plan sold by a broker averages up to 1.17 percent annually.
The difference in fees seems nominal, but over time (from birth to 18 years old) you will more than likely have a smaller return on your initial investment with a 1.17 percent operating fee. Some states offer a pre-paid tuition plan for state schools that doesn’t have an associated fee. You lock in on the price of tuition currently and not when your child enters school. You play early for a semester of community, public four-year, or private four-year. There is, however, a premium to cover tuition inflation.
What are the advantages?
Great question! There is no enrollment fee and for most states, there is either no minimum initial contribution or one as low as $25. Your maximum total contribution ranges from $300,000 to $375,000 depending on the plan, which can cover 4-year tuition at a state school or offset major costs at a private school. No matter what plan you choose, all plans offer tax deductions and tax exemptions. Some offer reward benefits from credit reward programs or financial aid benefits.
If your child decides traditional college isn’t for them some plans can be used for trade schools (you have to look into this on an individual base) or you can transfer the money to other family members. Of course an advantage is the interest you gain on your investment. The rate of return is low, but it is tax-free unlike the interest yielded from other taxable money market funds.
How can I avoid mistakes with managing my plan?
Researching a plan you’re particularly interested in and being well-read is the best way to avoid mistakes. Critically think about fees before choosing a plan, even if you are going with a prepaid option. While there isn’t a fee, you may not be guaranteed a return if tuition growth exceeds your investment. Illinois, Kentucky, Maryland, Michigan, Nevada, Pennsylvania, South Carolina, Virginia and West Virginia do not promise a guaranteed return.
Don’t look at your plan as a free-for-all. There are penalties if you pull money out early, use the money as an “emergency fund” or try to cover unqualified college costs. Be sure to ask about penalties and qualifications for 529 plan money when discussing your plan. Most importantly, don’t forget you have an open account. This is a long-term savings account and sometimes it can go unmanaged because more immediate and pressing money matters pop up. Remember, money is being pooled into your account from various places so if your account is relying on stocks, stay abreast of the stock market or choose a least volatile investment.
This is a little overwhelming. Do I have to start immediately?
Nope, but you won’t have much time to invest if you don’t. Remember, you can open an account now in your 20s before you even have kids. Even if you don’t end up having kids, you can transfer the money to a family member or keep it for yourself for graduate school. The plans seem overwhelming, but you can always shift to a new 529 plan (penalty free) or change your investment options once a year. There is also plenty of information on the Internet.
Get started today!