It is not news to anyone that the cost of a college education increases every year, growing at astronomical rates, faster than the overall economy and significantly higher than inflation. When I went to college, I had no college fund, but with the moral support of my family, hard work through high school, and a generous merit scholarship , I graduated from a private university with the same level of student loan debt I would have incurred at a local state one. I was tremendously fortunate to graduate in a good economy, with a great job that enabled me to rapidly pay them off as well. My husband similarly put himself through grad school. We know so many people our age or a few years younger, saddled with student loan debt a decade or more after we graduated, who literally have put their lives, family planning, entrepreneurial visions, and more on hold because they can’t afford to do otherwise. We know firsthand the importance of a college education, and we promised each other if we could afford to, we would help our children… and so, before they have even entered kindergarten, we started college savings plans for them.
Cost of College Today… and in 2030
According to the National Center for Education Statistics, for the 2011–12 academic year, annual current dollar prices for undergraduate tuition, room, and board were estimated to be $14,300 at public institutions, $37,800 at private nonprofit institutions, and $23,300 at private for-profit institutions. Below, we graphed the total cost of 4 year colleges, including tuition, fees, room and board for full-time undergraduates in current dollars since 1981. While annual growth rates have moderated slightly, the growth in the cost of a college education still significantly outpaces the growth of the broader economy and is certainly more than annual inflation.
If today, a year at a private, 4-year institution costs approximately $34,000, in 15 years when Big M is a freshman in college, at the average growth rate for the last decade of 1.4%, it will cost approximately $42,000. The same math for a public school? Today, a year at a 4-year public institution costs approximately $17,000. Public education costs have grown an average of 3.5% annually over the last decade. If growth continues at that rate, in 2030, Big M’s freshman year will cost approximately $29,000, or well over $100,000 for a 4-year degree. Even putting money in a savings account, which today earn next to nothing, will not easily cover that future bill! It is interesting to note the significant difference in growth rates between public and private education costs. Public education costs are growing faster than private education costs as 1) federal and state education subsidies are reduced due to budget constraints and 2) private education costs are often defrayed by growing, substantial private school endowments.
College Savings Plans
In 1996, Section 529 of the Internal Revenue Code created a federal tax benefit for education savings plans operated by a state or educational institution designed to help families set aside funds for future college costs. These are known as 529 Plans. Nearly every state now offers a 529 Plan, and it is important to know that plans from any state can be used to meet the costs of qualified colleges nationwide. Why should you choose a plan in your state? Details on that below…
The biggest reason to open an official 529 Plan to save for college vs. any other investment or savings account are tax benefits.
Federal Tax Benefits
While annual contributions to a 529 Plan are not tax deductible on your federal return, your contributions will grow tax-deferred until you choose to withdrawal them. So instead of losing money from your account to taxes every year, that money stays invested, and compounds until it is time to pay for college. So long as the funds are used to pay for the beneficiary’s college costs when they are withdrawn, they will come out federally tax-free. This tax treatment was made permanent with the Pension Protection Act of 2006. It should be noted, however, that President Obama’s most recent tax proposal to fund his plan for making community college available to all also proposed eliminating the tax-free withdraws from 529 Plans… allegedly to simplify the tax code and help the middle class. The uproar surrounding this proposal was enough to quickly curtail those plans… for now.
State Tax Benefits
States may offer tax benefits as well. These may include upfront deductions on contributions, or income exemption on withdrawals, in addition to the above federal benefits. For example, in the state of Connecticut, the Connecticut Higher Education Trust (CHET) offers several benefits to state residents. First, they offer program match contributions: Connecticut will provide $250 to families that open a 529 college savings account by their child’s first birthday or within the first year after an adoption. Second, they offer state tax deductions on contributions: up to $5,000 per year by an individual, and up to $10,000 per year by a married couple filing jointly, are deductible in computing Connecticut taxable income, with a five-year carryforward of excess contributions. If your state does not offer any tax benefits or matches to in-state residents, you can choose a plan anywhere. To compare plans nationwide and learn more about 529 Plans and benefits to residents in your state, visit SavingForCollege.com.
Donor Retains Control
While 529 Plans name a beneficiary (which can be a child, grandchild, or even yourself if you plan to go back to school), the donor maintains control of the account – when withdrawals are made and what they are used for. You can even reclaim the funds for yourself (although the earnings portion of distributions for anything other than qualified college costs are subject to taxation and a 10% penalty tax).
Once you set up your 529 Plan, it can be very low maintenance. You can set up automatic deposits for future contributions, and ongoing investment is handled by the Plan. The Plan is typically managed by the State Treasurer’s Office or a third-party investment company hired by the Plan to manage the funds. In Connecticut, the CHET is managed by an affiliate of TIAA-CREF, a financial services organization with more than 90 years of investment experience.
Simplified Tax Reporting
Unlike other investment or savings accounts, you will not receive a 1099 annually which outlines investment income reportable for tax purposes. You will only receive a 1099 in the year(s) you make withdrawals.
Substantial Deposit Limits
Anyone can take advantage of a 529 Plan, no matter your income level or age. Deposit limits, if any, are substantial – typically well over $300,000 per beneficiary, though this may vary by state. For the CHET plans in Connecticut, deposits are limited to $300,000 per beneficiary across all 529 Plans in their name, but accounts may continue to accrue earnings once the deposit limit is reached.
How to Open a 529 Plans
To open a 529 Plan, you must first choose a Plan to use and invest with. It should be evaluated as you would other mutual fund investment selections or the allocations you make via your 401K or IRA.
Review Options in Your State
I would start by reviewing the 529 Plans offered by your state of residence, especially if your state has a state income tax. Many states offer state tax deductions for contributions. In Connecticut, that’s a 5% savings on up to $10,000 for joint tax filers, or $500 a year. Some states may also offer tax exemptions on withdrawals, and matching programs for initial investments. If none of these apply in your state, then feel free to explore your options nationwide.
Compare Fees, Investment Options and Return Profiles
Fees on investment funds are charged annually, and are typically asset-based. What is reasonable? Most management fees on equity mutual funds range from 0.5-1.0%, with all-in expense ratios (which include management fees, administrative, brokerage and marketing costs) ranging from 0.2% to as high as 2%, with an average of 1.3-1.5%. Typically the more complex an investment strategy, the higher the management fee. And the smaller the overall asset-base (i.e. are the total fund investments $10 million or $10 billion), the higher the impact of typically minimal administrative and overhead costs. The fees on the CHET plan are relatively low, vary by your choice of investment strategy and range from 0.29% to 0.87% of the average daily net assets of your account.
You should also be careful of upfront or backend sales fees, often known as ‘loads.’ Plans purchased through a Financial Adviser or broker often include upfront sales fees to compensate the sales person. They can be as high as 5% of initial, and even subsequent, contributions, meaning you invest $1,000 – $50 goes to the salesperson and only $950 is actually invested. And you will still incur annual management fees. In general, funds with loads should be avoided.
When we first examined CHET a few years ago, it could only be purchased via FAs, and included a 5% front-end load fee, which basically negated any state tax benefit. When we set up the accounts this year, my husband was able to set up plans for our daughters directly via the CHET website. The forms were easy to complete, as were automatic deposits going forward. Be sure to have personal information readily available, like social security numbers for yourself, your spouse and your intended beneficiaries. All in, it took about an hour to set up both accounts.
If you are evaluating multiple plans, you may want to compare the investment options offered – are there varying strategies: low risk, moderate, aggressive? Do they offer age-based strategies that automatically adjust as the beneficiary approaches college? Just like with your 401K, it makes sense to invest more aggressively early, when your child is very young, and be more conservative as they approach entry to college to be more certain of the funds available to pay for school. Some Plans will offer managed options that automatically adjust to match this strategy as your child ages.
Lastly, you may want to compare return profiles. Be sure to compare return profiles for similar levels of risk (moderate vs. moderate, and compare the asset class mixes) and like time periods.
Have you started a College Savings Plan for your child? What is the best plan offered in your state? What have you found to be the best option nationwide?
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