As bewildered families search for ways to save for their children’s growing education costs, 529 college savings plans – tax-advantaged investment accounts specifically for education spending – look more appealing than ever.
In 2020, after an initial decline and a dramatic recovery in equity and bond markets, total assets of 529 plans rose 18% to a new record high of $ 394 billion, according to a new report from Morningstar. The average plan balance also peaked at $ 28,679 in December 2020, after the average account balance increased 10% in 2020, according to the College Savings Plans Network.
Despite the uncertainty of the Covid-19 pandemic, families who saved in 529 plans had the opportunity to benefit from a year of investment that brought returns higher than analysts’ expectations – even higher than the historical average. The average returns of the S&P 500 Index were 18% in 2020, higher than its average historical annual return of around 10%.
If you’re considering investing in a 529 plan, here’s what you need to know about their recent performance and how to craft a savings plan that meets your family’s goals.
529 plan balances hit all-time highs in 2020
First, a brief overview of 529 shots. Named after the section of the tax code that exempts these types of savings accounts from federal income tax, 529 plans are a type of investment account that allows money to grow tax-free. and allows tax-free withdrawals on eligible education expenses.
States provide these plans, and families can open an account with any state’s plan, regardless of their residence. Many states offer an additional tax credit or deduction for residents only or for all plan participants.
In 2020, the growth in the total of 529 assets was due to both an increase in new contributions from families and market gains, according to the Morningstar report.
More contributions reflect the fact that 529 diets are growing in popularity. The share of families who used funds in a 529 account to pay for their college education increased from 21% in the 2018-19 school year to 37% in 2019-20, according to a 2020 report. report by Sallie Mae and Ipsos.
But despite an increase in contributions and investment gains, 529 savings typically only cover a small portion of a child’s school fees. For example, among parents who contributed to 529 plans or other savings from university funds for their child’s college education, those savings covered only 11% of the child’s cost of education on average in 2020, according to the Sallie Mae and Ipsos report.
Here’s why: Even though the rise in tuition fees slowed during the Covid-19 pandemic, saving for college is still a hill to climb. Across all four-year public and private institutions, the annual price of tuition, fees, room and meals increased 133% from 1999 to 2019, ignoring inflation, according to the National Center. education statistics. Tuition, fees, room and board at a private four-year nonprofit college cost $ 48,965 per year on average in 2019-2020.
The costs go down but remain expensive for some plans
Minimizing fees is a crucial aspect of choosing a 529 plan, as it’s important that most of your savings go towards college expenses. But plan members can expect to pay fees for managing the program, maintaining accounts, and managing plan assets. The assets of 529 plans are managed by investment companies such as Vanguard, TIAA and BlackRock, and some of these companies are also program managers for 529 plans on behalf of the states.
In 2020, fees for all types of plans went down, according to Morningstar. Plans sold directly – that is, those in which families can participate directly through the states that offer them – charged an average fee of 0.35% for plans that rebalance investments based on the age of the beneficiary. , up from 0.39% in 2019, according to Morningstar. In contrast, fees for plans sold by an advisor based on age, which must be purchased through financial advisers, charged an average fee of 0.89% in 2020, up from 0.91% in 2019.
Plans sold by advisors charge higher fees in part because they typically include more actively managed funds. These are more expensive than index funds, the type of investment options favored by direct selling plans. When researching 529 plans, make sure you know all the fees you will be charged and go for a direct sales plan if lowering fees is a top priority for you.
How to get the most out of a 529 plan
529 plans are more flexible than many families can imagine. Along with the direct sell and advisor sell options, there are also prepaid tuition plans and traditional savings plans. A prepaid tuition plan gives families the option to purchase tuition credits from a state public institution at current prices so that a beneficiary can use them in the future.
Since a beneficiary must attend a certain type of school to use the savings of a prepaid tuition plan, an Education Savings Plan 529 – which allows the beneficiary to use the funds at any facility. eligible than he wants – is a smarter choice for many people. .
There are a surprising number of other uses for the savings in a 529 non-prepaid tuition plan. For example, up to $ 10,000 per year per recipient can be used for K-12 tuition. In addition, up to $ 10,000 in total from a 529 plan can be used to pay off the recipient’s student loans, and an additional $ 10,000 can be used for student loans for each of their siblings.
But a key way to get the most out of 529 plans is to understand and closely follow their withdrawal rules. Here are the key points to remember:
- Eligible education costs that you can pay tax and penalty free include tuition fees; fresh; room and board; books, supplies and equipment needed for the courses; and the repayment of the student loan for the beneficiary or his siblings.
- Transportation, insurance, and room and board costs beyond the school’s official calculation for room and board costs are not considered education costs.
- If you withdraw 529 funds from the plan to pay for non-qualifying expenses, you will pay federal and possibly state income tax, and you will pay a 10% penalty on any investment income that is part of the withdrawal.
- You can transfer the plan to another eligible beneficiary if the original beneficiary does not need the funds. For example, if your child decides not to go to college, you can transfer their 529 plan to one of their parents, siblings, children, nieces, nephews, first cousins or their spouse, who can then use the funds for their own qualifying education. expenses.
Other ways to pay for college
If 529 funds aren’t enough to cover all of your child’s school fees, use these best practices to think about how to cover the rest and minimize student loan debt.
- Have a frank conversation with your child about how much you can afford to contribute towards college fees before they apply to schools. You can choose to save for some of their expenses, pay another portion with your income while they are in school, and encourage them to cover another. But it’s important to understand your own college budget before your child begins to identify schools that interest them.
- Consider limiting your child’s student loan borrowing to what they expect to earn in their first year out of school. So, if they are probably earning $ 40,000 a year as a newbie employee, they shouldn’t borrow more than $ 40,000 in total throughout their college education.
- Federal student loans are less expensive and offer more generous repayment programs than private student loans. They come with annual loan limits for undergraduates, which provide a built-in maximum alternative, as a rule, for the amount your child should consider taking out on student loans. The federal borrowing limit is $ 31,000 during their undergraduate studies for dependent students, for example.
- Parents can borrow a lot more in Federal PLUS loans – up to the student’s total tuition cost, in fact – but these loans have higher interest rates and fees than prime student loans. cycle. If you need to borrow as a parent, you may want to compare your potential repayment rates, fees, and terms for Parent PLUS Loans with Private Student Loans for Parents, with the understanding that private loans generally offer fewer options. reimbursement if you experience financial difficulties.
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At the end of the line
As the balance of 529 plans increases, it is hoped that more parents can use these savings to avoid borrowing student loans for themselves and their children. When considering when and how to save in a 529 plan, remember that like any investment, starting early and saving consistently gives you the best chance for success and peace of mind when the season for college and career applications is over. financial aid scholarships inevitably happen.