Six Strategies to Help Maximize Growth
With the rising cost of education, saving for college can be a daunting task. If your children are young, you may wonder how to plan for something so far in the future with so many unknown factors. If your children are older, you may be worried about how to tackle such a steep price tag just a few semesters away. Whether you hope to pay the full cost of your children’s college education or wish to support them in a smaller way, the following strategies can help you achieve your college planning goals.
Strategy #1 – Utilize a 529 Plan
A 529 plan is a college savings account that can help you save for education expenses with certain tax benefits. Earnings in a 529 plan can be withdrawn tax-free at the state and federal level when used for education expenses.
For example, you contribute $30,000 to a 529 plan. Due to investment growth, the value of the account is now $45,000. Typically, the $15,000 of growth would be taxable. Those taxes would decrease the total amount available to pay for college. However, if you use the $45,000 for education expenses, you can avoid tax on the $15,000 in earnings.
Strategy #2 – Know Your State’s Benefit
Not all 529 plans are created equal. Each state has its own plan, and many states offer incentives to residents for using their plan. This sometimes means a state tax deduction today for contributions to a 529 plan, which can result in even greater tax savings. If your state offers an incentive to save within its plan, this is almost always the best option. (See if your state offers tax deductions for contributions here.) If your state does not offer incentives, look for a plan with low-cost index funds.
It is important to note that investing in your state’s 529 plan does not mean your child must attend a public state university. 529 funds can be used to attend any school in the country.
Strategy #3 – Start Early
As with most financial goals, the earlier you start saving the better. A child can be listed as the beneficiary of a 529 plan as soon as his or her Social Security number is issued. If you want to start even earlier, you can open a 529 plan in your own name when you’re expecting and change the beneficiary to your child after he/she is born.
Regardless of when you establish the 529, it’s important to have a clear plan for saving. Determine whether you will contribute monthly or at a set time each year. If you make a monthly contribution of $200 for 10 years with a 6 percent annual growth rate, you will have $30,000 in savings. This is enough to cover a year of most in-state public tuition, plus room and board.
Strategy #4 – Invest Wisely
After opening a 529 plan, you will need to choose the plan’s investments. The younger your child is, the more exposure you can have to growth investments such as stocks. As your child gets older and college gets nearer, you will likely want to shift exposure to more conservative investments such as bonds.
Many plans offer age-based investment options that focus on growth in the early years and become more conservative the closer the student is to college. It is important to regularly check in on your investments to make sure they continue to match your time horizon and risk tolerance.
Strategy #5 – Watch Out for Fees
Fees can be a big deterrent to growth, which is why it’s important to look for high-quality, low-cost investment options. This may mean investing in index funds, which are generally the lowest cost options. Historically, index funds have had a high probability of outperforming actively managed (and more expensive) funds over the long term.
Also, be cautious of 529 plans offered by a broker, as these often include a “load,” or broker’s commission, of up to 5 percent. That greatly cuts into your savings potential. You’ll have plenty of extra fees to pay to your child’s university; try to avoid paying them to a broker.
Strategy #6 – Make it a Family Affair
When friends and relatives ask what they can buy for holidays and birthdays, encourage them to save in a 529 plan as well. For example, grandparents can open their own 529 plan and designate your children as beneficiaries. If they live in a state that offers tax deductions for contributions, they can receive the tax savings today and your children can benefit from the contribution’s future growth.
As your children get older, show them the 529 investment statements and discuss how you and other family members are saving for their future. It’s a great lesson on saving, investing and the value you place on their future education.
At Creative Planning, we incorporate college planning objectives as we work with clients to build comprehensive financial plans. Our advisors consider your current financial situation, any challenges you face and your specific financial objectives as they work to develop strategies to help you achieve your personal financial goals. If you would like help with education planning for your children, please contact us.