Last week, I announced that we’re having our first child, and I talked about some of the financial impacts and decisions that we’ll face. We received an incredible amount of valuable feedback and advice, for which my husband and I are both thankful. In a followup comment, Investor Junkie got us thinking about saving for college in a 529 plan. I decided to take him up on his advice and started looking into it.
What is a 529 plan?
A 529 plan, also known as a Qualified Tuition Program (QTP) is a tax-advantaged savings plan. Its nickname comes from the section of the Internal Revenue Code that authorizes it. Contributions to 529 plans are not federally tax deductible, but qualified distributions are, making it a bit like a Roth IRA for education. On top of this, some states offer income tax deductions for contributions for the plans.
As far as qualified expenses go, the money in a 529 plan can be used for tuition, fees, books, supplies, a computer or laptop, and room and board at an accredited vocational, college, or university in the United States.
There are two types of 529s – prepaid plans and savings plans. As the name implies, prepaid plans have you buy at a locked-in tuition price. Savings plans are more like IRAs, where you can choose from different investing options to meet your goals. It’s also worth noting that you can even start a 529 plan for an unborn child by naming someone else as the beneficiary and transferring it to them when they are born.
Each of the two major types of plans has their own pros and cons that you have to weigh for yourself to see what would be right for your family.
Pros of prepaid plans
- States usually guarantee their own plans
- Predictable, fixed payments based on child’s age
- No nasty tuition surprises at the end
Pros of savings plans
- All qualified expenses are covered
- Flexibility to go to college anywhere without complications
- No age limits
Based on the above information, if we decide to go the 529 route I’m leaning more towards opening a savings plan for our child.
Why save for college now?
There are a few reasons why you might want to start saving for college now rather than later than waiting to do so later.
- Lower annual contributions – I know it may seem crazy to talk about college so early in the game, but you can minimize your monthly obligation if you start sooner rather than later. Giving yourself more time can be a huge asset.
- Gift tax limits – Even if you’re able to set aside a large sum in a short period, you need to be aware that 529 plan contributions are subject to gift tax limitations. The gift tax exclusion is currently $13k/year, though a “five year election” lets you bunch five years worth of contributions into just a single year.
- More time to build up enough to cover it all – It’s our hope that our child doesn’t have depend on student loans to pay for his/her education.
- Rising tuition rates – Even attending a good quality state school can cost a lot of money. As we’ve been seeing locally with UNC’s tuition hikes, we know that that college will be expensive, so we’ll need all the time we can get.
If our child decides for some reason he/she wants to attend a much more expensive school, they’ll be free to do that. We won’t, however, support that particular financial decision, and they will more thank likely have to apply for student loans to cover the costs.
Prioritizing expenses and looking at alternatives
We’re definitely planning on setting aside money for our child’s education expenses in the relatively near future, but right now isn’t an ideal time. While I’m not in Financial Peace University, I do like the order of financial goals that Dave Ramsey encourages. There are some bills, savings, and debts that we’d like to handle before we tackle college savings.
Besides getting our house ready for the new addition, we want to pay off some debts in hopes of improving our monthly cash flow. Hopefully, we’ll be able to re-evaluate our financial situation in the near future so we can get started.
We also want to explore other alternatives before committing to a 529 plan. For example, Coverdell Education Savings Accounts (originally referred to as Educational IRAs) provide another avenue for college savings, and we want to research those sorts of options before making a decision.
For those of you who are ready to start a 529, Nickel has written some wonderful posts on the topic, including the myths associated with 529 plans, some facts about 529 plans and scholarships, and also a list of some of the cheapest plans out there.
Your thoughts on 529 plans
Okay… Now I’m curious to get your thoughts and feedback on this. How many of you have funded a 529 account for your child(ren)? How did you go about selecting your 529 plan? Do you have enough allocated in the account for expected tuition costs? If not, are you going to continue saving, or do you expect your child(ren) to come up with the difference?