How to Save for Your Child’s Education with a 529 Plan
By Barbara O’Neill, Ph.D., CFP®, Financial Resource Management Specialist, eXtension Military Families Learning Network (MFLN) & Rutgers Cooperative Extension
Saving for a child’s post-secondary education is an important financial goal for many military families. There are three ways that servicemembers can pay for college or post-secondary vocational/technical school costs:
- “Pay-as-you-go” out of pocket from current income (this usually requires that large debts, such as a mortgage, be paid off to free up available cash)
- Borrow money (student loans) and/or acquire money (scholarships and grants)
- Save money over time and earmark it for education expenses
A common college savings vehicle is the 529 college savings plan. Created in 1996 by Congress under Section 529 of U.S. Code 26, technically named “Qualified tuition programs,” a major benefit of 529 plans is that earnings grow tax-deferred and are tax-free if used for qualified education expenses. Some states also offer their state residents an income tax deduction for money contributed to their state 529 plans.
Parents can invest in the 529 savings plan of any state, but certain benefits, such as tax deductions for deposits, are generally limited to in-state residents only. Shopping around is a must. Plan features vary from state to state and even within a state as some states have multiple 529 college savings plans.
While 529 college savings plans are administered by individual states, management services are generally provided by financial services firms. The actual investments in these plans are typically mutual funds, including age-based “target date” type funds that follow a so-called “glide path” that gets more conservative (i.e., less stock in the portfolio) as a beneficiary (child) gets older. The account balance depends on the performance of the selected 529 plan investments.
The best 529 plans have affordable minimum deposits, state (as well as federal) tax advantages, low expense ratios and fees, good historical performance (relative to market indices), and experienced management. Another excellent resource to gather data to make an informed comparison among various state 529 college savings plans is the College Saving Plan Network (CSPN), a non-profit organization comprised of state higher education program officials.
Two other college savings plan options are:
- Coverdell Education Savings Accounts (ESAs) - Formerly known as Education IRAs, ESAs are another tax-advantaged way to pay for college. Except for investing in life insurance contracts, you can buy and sell what you want whenever you want.
- Uniform Gifts to Minors (a.k.a., custodial) accounts – this is a type of custodial account where a parent, grandparent or other adult is custodian for the account and makes all the investment decisions until the child for whom the account was opened reaches the age of majority.
Parents can also use taxable accounts in their own name to save for college. Interestingly, taxable accounts are the most frequently reported college savings vehicle. Perhaps this is because they are simple to open and they provide parents with the greatest amount of flexibility and control.
Like saving for retirement or any other financial goal, the earlier one starts saving for college, the better. Retirement savings trumps college savings, however, when parents only have enough money to save for one of these goals. Students have the option of obtaining loans to fund their education but, with the possible exception of reverse mortgages, nobody lends money to pay retirement living expenses.
For further information about college savings and student loans, use these free tools and publications from FINRA and Rutgers NJAES Cooperative Extension:
- College Savings Calculator
- Smart Saving for College – Better Buy Degrees: 529 Plans and Other Savings Options
- Planning Ahead for the Cost of College