Jon Medeiros, Director of Finance at Ovia and blogger behind Work.Life.Finance., knows a lot about money. He’s also the proud father of a baby girl, so he knows a little about stress too. Here’s his advice for thinking about college savings for your little ones.
It might just be me, but I don’t think saving for college gets enough attention in the personal finance world. Perhaps it’s because millennials are so hamstrung by our own college tuition that we can’t fathom putting money toward another person’s education, especially one that’s so far away. One of the biggest financial topics in 2016 is student loan debt, so why don’t we talk about saving for college to help ease the burden for our cute little Generation Alphas?
If you start typing “expected college” into Google, one of the top suggested results is “expected college tuition 2030.” A few years ago, a US News report estimated that when my 9-month-old is 15 and starting to think about where she wants to go to college, the total cost of a four-year degree at a public institution will be more than $205,000.
Let’s say I conservatively want to have $100k saved up for Miss MGM to go to college. If only there was a tax-advantageous vehicle where I could start investing money that can be used to pay for college. How about a “qualified tuition program,” or as it’s commonly referred to in financial circles, a 529 account? There’s a ton of information out there about these vehicles (I recommend starting with Fidelity.com), so I’m going to give you the five big things you’ll need to know if you want to send your pride and joy to an expensive liberal arts college in the Northeast.
- Taxes, taxes, taxes
Contributing to a 529 plan is tax advantageous in three ways. First, you may be lucky enough to live in a state where contributions to a 529 plan are deductible on your tax return. This is a nice perk because you can owe less in taxes or get a bigger refund. Second, earnings on your investment grow tax-deferred in a 529. This means you won’t have to worry about paying taxes on your investment earnings until much later on, once you withdraw the money. The third, and perhaps best, tax benefit is that the distributions themselves are tax-free if used for qualified education expenses. So you would only be responsible for taxes on the earnings (deferred until the money is withdrawn, as noted above), not the original contributions.
Speaking of contributions to a 529 account, have you called your brother/sister/parent/second cousin to say hello lately? Because what better way to say congratulations on having a baby than dropping some cash into that college fund? Don’t get me wrong — toys are great too, but gifts to a 529 aren’t nearly as loud or messy. There are even some favorable gift tax rules around contributions to a 529, in case Uncle Joe is also trying to trim down his tax bill.
Not only is saving for college an investment for your child’s future, it’s also literally an investment vehicle. When you make contributions to a 529 account, they are invested in a mutual fund that will ideally grow over time (something like 6-8% annual return isn’t a bad rule of thumb). These mutual funds are usually “target date” funds that start off more aggressive when your child is young and gradually re-balance to become more conservative as they approaches college age. Basically, in addition to contributing your own dollars to the 529, those dollars should grow over time.
- Savings hack
The most basic way to save in a 529 is to literally transfer funds from your bank to the college savings. There is also a creative way to save beyond transferring money from your checking account. Fidelity has an excellent credit card that gets 2% cash back on all purchases, which can then be automatically deposited directly into your Fidelity 529 account. That 2% cash back can add up quickly. Speaking of adding up quickly, perhaps my most important tip is:
- Get started
The power of compounding is real. Assume your future CEO is 8 years old, just about to enter third grade. In 10 short years, they will be entering college, and you realize you need to start saving. All you have to contribute is $200 a month, which you smartly invest in a 529 account that grows at about 6% annually. In 10 years, you will have a bit more than $33k saved up. Not too shabby. Now, assume you opened that account 8 years earlier, a couple months after having your child and getting a social security number. Still contributing the $200 a month, after 18 years you’d have almost $80k! What’s more, you’d have about $26k more in earnings from the investment, aside from the additional 8 years of contributing $200 per month. That, my friends, is the impact of starting early.