It’s back-to-basics week for me and time to talk about getting started saving for college. If you want your children to go to college, you need to save. Period. That’s the easy part. Harder is where and how much.
People worry that they’re going to lose out on financial aid if they save. Yes, your savings will add a small amount to your EFC (or SAI starting next year). However, the small amount of financial aid you give up is more than offset by the additional choices your child will have because you’ve saved. Assets such as college savings add 5.64% of their value to your EFC/SAI. That means that every $1,000 of savings will increase your EFC/SAI by $56.40, leaving you ahead by $943.60. In addition, research has shown that students whose families have saved for college– even very small amounts– are more likely to enroll in and graduate from college than those with no savings.
The vast majority of families will find they are best served by saving in a 529 account. 529s have several advantages:
- Tax-free growth and distributions for qualified expenses, which now include not just college costs but K-12 expenses and up to $10,000 in student loans
- More than 30 states offer their residents tax deductions or credits for contributions to the state’s plan
- Less well-known but perhaps most important of all, qualified distributions from 529s are not reported on the FAFSA so they won’t add to your income and increase your EFC/SAI
- Any 529 can be used at any college that participates in federal student aid programs. This includes many international colleges and universities as well. Furthermore, 529s can now be used for trade schools, some gap year programs, and computer purchases.
How do you choose a 529? If your state offers a tax break, then contribute to your state’s plan. If not, you can research other plans at savingforcollege.com. Look for low-cost plans that offer broadly diversified investment choices, such as Utah’s my529 or Vanguard’s 529.
Once you’ve chosen a plan and set up accounts for your children– each child gets their own– you need to fund it. Rather than trying to work back from the cost of college, just figure out an amount you can afford to contribute every month or every quarter, and set the account up for automatic contributions. If you can contribute the full deductible amount annually, wonderful! Families’ financial lives are not linear– your cash flow changes constantly as life comes at you– so the idea that you could come up with a single number that you’ll contribute every month for 18 years is a recipe for disaster. Just do something that works for you now. You can always increase it in the future.
Now that you’re contributing, take it one step further and let your children’s grandparents, godparents, and others who care about them know that you’ve set up 529 accounts and that they can contribute too. Many plans have a gifting link that allows others to contribute directly to the child’s account. If not, you can send out contribution instructions and then send reminders before your children’s birthdays, Christmas and other gift-giving events. If others contributed $100 annually to your child’s 529 starting when she’s born, she might have more than $3,500 extra for college.
What happens if you don’t use your 529 for college? You have a lot of options. You can name a different beneficiary or simply withdraw the money. If you withdraw it because the 529 was overfunded due to scholarships, you’ll simply owe taxes on the growth in the account. You can distribute it out to your child in a (presumably) lower tax bracket to minimize that cost. If it’s a nonqualified distribution– money that doesn’t pay for qualified college expenses– then you’ll pay a 10% penalty on the growth in addition to taxes. You can change the beneficiary to any family member, including yourself. I learned recently that some colleges offer golf programs and a parent had named himself the beneficiary of his child’s overfunded 529 and went to golf school with the money.
Just remember that the time window for funding and growing your college savings is short, so the sooner you get on it, the sooner your money gets to work for you.