Paying for CollegeMay 2, 2019
- The earlier you start setting money aside, the longer that investment will have to benefit from tax-deferred growth potential.
- Consider setting up an automatic monthly transfer into a 529 account for the benefit of your child.
- The more you save now, the less you may need to borrow in the future.
Thinking about paying for your children's college expenses can be overwhelming. Even if you don't think you will be able to cover 100% of the costs, you can still start saving to pay part of them. A 529 college savings plan—offering tax-deferred growth potential and tax-free withdrawals for qualified college expenses—may be an ideal way to do so.* Also, the U.S. tax reform measure that passed in December 2017 allows state-sponsored 529 plans to offer tax-free withdrawals up to $10,000 per year per child for qualified elementary and secondary school tuition expenses. "Look at every dollar you save in a 529 account as a down payment on a college education," suggests Judith Ward, CFP®, a senior financial planner with T. Rowe Price. "Starting to save is the first and most crucial step."
The earlier you begin setting money aside in a 529 account, the longer that investment will have to benefit from tax-deferred growth potential. "If you can work a couple hundred dollars into your monthly budget to help offset the future expense of college, you will be so much better off by the time your child is ready to enroll," Ward says.
Note that 529 plans vary from state to state, with each offering different costs, investment options, and incentives. For example, if you open a 529 plan in your state of residence, you may be eligible for a state income tax deduction or tax incentive—although some states provide these tax benefits no matter where the plan is offered. Also consider a plan's investment flexibility, initial required contributions, and administrative fees. Keep in mind your time horizon when choosing among investment options.
Look at every dollar you save in a 529 account as a down payment on a college education.- Judith Ward, CFP®, T. Rowe Price senior financial planner
Consider setting up automatic monthly transfers or payroll deductions (if available) into a 529 account for the benefit of your child so you can accumulate savings regularly. Plan to increase the savings amount as your financial resources permit. Of course, your own financial health should take precedence, and saving for your child's education shouldn't jeopardize your retirement savings plan.
Furthermore, don't assume you'll have to handle all the saving yourself. One benefit of 529 plans is that anyone can contribute to the account. You can take advantage of this feature by encouraging family members to give the "gift of education" to mark milestones such as birthdays or graduations. Many 529 plans make this gift giving easy, and it's a great way to make it a family affair.
Saving for education can lead to much lower total expenses compared with borrowing. Consider the example below of saving in a 529 plan versus borrowing to cover $40,000 in college costs.
Figures are pretax and rounded to the nearest $1,000.
Assumptions: To cover $40,000 of college costs, you would need to save $105 monthly before college for 18 years at a 6% average annual rate of return compounded monthly. When borrowing $40,000, assuming a 5% average annual interest rate, you would pay $424 a month for 10 years after college. All 529 withdrawals are assumed to be for qualified educational expenses at the beginning of college; 529 contributions, interest accrual, and loan repayments occur monthly, at the end of the month. This chart is for illustrative purposes only and does not represent any specific investment.
SAVE WHAT YOU CAN
Of course, many families will need to use loans to help pay for education expenses. Just remember that saving as much as possible in a 529 account now can mean less borrowing—and less money spent paying back interest—later. (See "Saving vs. Borrowing.") And if your child ends up receiving aid or scholarships, you can change the account beneficiary to another family member—or even yourself.
“Saving as much as you can now for that tuition bill is one of the best things you can do to minimize the amount that will need to be borrowed later,” says Ward. “Even planning to put a down payment toward college expenses can really help.”
*Earnings on a distribution not used for qualified expenses may be subject to income taxes and a 10% federal penalty.
Please note that a 529 plan’s disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing.
You should compare any college savings plan with the college savings program offered by your home state or your beneficiary’s home state, which may offer state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s 529 plan.
This material has been prepared by T. Rowe Price for general and educational purposes only. This material does not provide fiduciary recommendations concerning investments or investment management. T. Rowe Price, its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.
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