Whatever Your Income, This College Savings Plan Is Your Best Bet

By Mauri Elbel
November 30, 2012

Many parents want to get a jumpstart on college savings, and the smartest strategy depends on a family's own financial situation. Whether you can afford to set aside $25 per month or $26,000 per child each year, one savings option offers a universal fit for most families.
 
This tool "offers flexibility of contributions but may also provide a meaningful part of substantial estate planning strategies as well as tax-free growth, and in some states, tax deductible contributions," said Suzanne Krasna, a certified financial planner and owner of Krasna Financial Group LLC in Walnut Creek, Calif.
 
That sounds pretty appealing if you want to be confident that you can afford to send your child to college.
 
The tool Krasna is describing is a 529 college savings plan, authorized by Section 529 of the Internal Revenue Code as a tax-advantaged means for saving for future college costs.  
 
"529 college saving plans can be a doable option for every family," she said.
 
While a 529 plan isn't the best choice for absolutely every family -- because you should be fairly certain at least one of your children is going to college -- Krasna said it's important that your college saving strategy sits alongside other financial planning basics such as retirement, emergency savings, and short-, medium- and long-term savings goals. 
 
"You must first ask yourself what your personal, professional and family goals are," said Krasna, who has worked with hundreds of families throughout her 30-year career. "All of these goals impact how you are going to focus on your savings and investments throughout your life."
 
Once a family has determined how much they can afford to put aside for college, Krasna said 529 plans are a great savings vehicle because their flexibility makes them well suited to a wide range of budgets.
 
"Most families will find that 529 plans can be convenient, easy to understand and implement," Krasna said.
 
 
It's important to know that there are two versions of the 529 plan -- the college savings plan and the pre-paid tuition plan. With the savings plan, money is deposited into an account through which investments are made -- typically conservative mutual funds -- and the money can be used for higher education expenses, including tuition, room and board, etc. The pre-paid plan is exactly what it sounds like: You pay up front for tuition only, and rates are locked in when you start saving.
 
With the continually increasing costs of higher education -- many financial experts assume an annual 7% inflation rate when calculating future college costs -- families should avoid putting college savings on the back burner. Today, a four-year, in-state public college costs an average of $18,000 per year, while out-of-state and private schools range between $30,000 and $50,000-plus per year -- and those numbers will only go higher over time.
 
Whatever your income level, Krasna shares tips and scenarios that will help you make the most of a 529 college saving plan.
 
Lower Incomes 
 
Families making just enough money to cover living expenses with a limited amount remaining for discretionary and savings could ultimately establish a 529 plan for each child but should start with the oldest first.
 
"If your savings dollars are really minimal, just get one 529 plan going," Krasna said. "Even if you have three children, you might focus on one 529 plan for your oldest child and over the next few years start one for the second and then later another for the third."
 
One of the biggest benefits of a 529 plan is that the beneficiary can be changed -- so if one child opts out of college, the funds can be transferred to another child. Another smart savings strategy for families trying to build a child's college savings? Encourage family and friends wanting to give toys and gifts to make contributions to the child's educational fund instead.
 
Hypothetical savings scenario for low-income families: Your first child, a 1-year-old, will start her education at a two-year public school 17 years from now, which has an estimated annual cost of $3,100 today. Assuming a 7% annual inflation rate, the projected tuition cost when she is 18 years old is $20,270. You have already put aside $1,500 and are planning to save $400 per year. To cover 100% of the projected cost, you would need to save an additional $156 a year for a total of $556 yearly for this child ($400 + $156 = $556). Saving an additional $156 a year is the equivalent of setting aside $1,885 today. This assumes a hypothetical 5% rate of return.
 
Middle Incomes
 
As a family's income increases, allowing for savings in higher amounts, middle-income families could make higher monthly or annual contributions of $50 to $100 or more per child. Some families receiving inheritances might consider making lump-sum contributions to help cover any shortfalls in college savings. Grandparents or other family members may want to make substantial estate planning gifts by establishing a 529 plan themselves and naming their grandchildren or nieces and nephews as the beneficiaries.
 
Consider this hypothetical savings scenario for middle-income families: A family has two children, ages 6 and 2, and an income of $72,000. Grandparents gift $2,000 for each child, and parents transfer from savings $500 for each into a 529 savings plan. Each child's account will have monthly deposits of $100. The 6-year-old will start college in 12 years at a public four-year, in-state school with a current annual cost estimated at $17,100 per year and a projected total cost of $170,992 assuming 7% inflation. With $2,500 contributed already and additional annual deposits of $1,200 per year, assuming a hypothetical 5% rate of return, the family will have a shortfall of $141,423. They would need to make additional contributions of $6,324 per year as incomes increase. The 2-year-old will start in 16 years attending a public four-year, in-state school with an annual cost estimated at $17,100 per year today but with inflation factored in, a future total cost of $224,138. The identical funding will be made over the years with plans to cover 50% of the cost. With a hypothetical 7% rate of return, the shortfall will be $62,186. Saving an additional $132 a month for the youngest child will help the family reach the goal of fully funding 50% of the cost, equaling $112,069.
 
Upper Incomes
 
Families with higher incomes and greater assets could chose to make maximum annual gifts for each child's 529 college savings plan. Each parent can contribute $13,000 annually per child per year, or together they can contribute $26,000 per child per year. Alternatively, upper-income families may want to make a single contribution of $65,000 (the equivalent of $13,000 for five years) per parent per child, or $130,000 together per child without making any other contributions for five years. For families that can afford to make high contributions, they make sense because unlike many other non-retirement savings accounts, a 529 college savings plan allows money to grow tax-free. In some states, contributions are tax-deductible, and 529 plans allow for tax-free withdrawals for college costs. Additionally, some estate-planning strategies could include contributions made to 529 college savings plans because they can considered as gifts that can reduce the value of a family's taxable estate.
 
Here's one hypothetical scenario for upper-income families: A family has an income of $216,000 and four children -- ages 16, 14, 9 and 6. Grandparents wish to make a one-time gift for each grandchild of $13,000, and parents are able to transfer from other savings and investments the following amounts for each child with the goal being a total college contribution of $130,000 for each child.
  • 16-year-old: $13,000 + $130,000 (broken down into a lump sum of $65,000 from each parent)
  • 14-year-old: $13,000 + $26,000 ($13,000 gift from each parent) + $11,375 annually for the next eight years
  • 9-year-old: $13,000 + $13,000 + $8,667 annually for the next 12 years
  • 6-year-old: $13,000 + $13,000 + $6,500 annually for the next 16 years
 
The Investing Answer: The sooner families start saving for college, the longer the power of tax-free compounding works for them. If college is in your child's future, 529 plans offer a simple, tax-efficient way to help families at all income levels meet future educational costs. Talking to a certified financial planner who specializes in working with families now will pay off in the long run by equipping you with a solid plan to achieve your savings goals.