The high cost of providing your child a college education is staggering. How can you plan for this large number? And will the tuition costs continue to climb?
According to The College Board, the average 2014-2015 tuition increase was 3.7% at private colleges, and 2.9% at public universities. However, looking back at the last decade, the 10-year historical rate of increase is approximately 5 percent. These figures are substantially higher than the general inflation rate, and also higher than the average increase in personal incomes.
Saving early for education is one of the most significant decisions parents need to make, especially as the tuition costs climb. One of the most popular options is the tax-advantaged 529 savings plans which are offered by most states.
What Is a 529 Plan?
A 529 plan is a college savings account that was introduced in 1996 to help taxpayers save for college expenses for a designated beneficiary.
These plans, named for Section 529 of the federal tax code, are federal tax exempt and often have tax benefits at the state level for in-state residents. This only applies to states that have an income tax. Any U.S. citizen or resident alien at least 18 years or older can open a 529 account. Usually, the beneficiary is a child, grandchild or younger relative. However, there are no age limits for opening a plan. An adult can also open a 529 plan to save for his or her own higher education costs.
How does it work?
Individuals can save for college in a tax exempt basis. Eligible institutions include most accredited colleges and graduate schools, including professional and trade schools. Foreign schools with attending students who receive federal financial aid also qualify. Contributions apply to a variety of qualified educational expenses, including tuition, books and room and board for those attending at least half time.
Approved transactions are often referred to as qualified withdrawals and vary slightly from plan to plan. If the funds are used incorrectly for unauthorized expenses, the tax deductions will be recaptured, and there may be additional monetary penalties. Check carefully that the expenses are for those eligible expenses.
On December 18, 2015, Congress passed the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), which introduced certain improvements to 529 Plans. One important aspect of the act is the inclusion of computer expenses as a qualified expense. This includes a computer, printer, computer software, or Internet access and related services if they are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible institution. This change is retroactively effective for tax years beginning after December 31, 2014.
Within each state, there are often multiple plans from which to choose, and state plans are sold nationally (regardless of where the account owners resides). Don’t limit yourself to only reviewing your state’s offerings, as some states offer lower fees including maintenance and investment fees. However, be aware that some states give in-state resident tax credits for contributions.
Understand Your 529 Investment Choices
In most cases, the money you contribute will be invested in large, widely held mutual funds managed by well-established financial companies such as on favorite Dimensional Fund Advisors (DFA), Vanguard, TIAA-CREF and many others. Each plan option includes a mix of mutual funds, and you can generally pick your plan with one of two approaches.
The first, an age-based option, automatically adjusts your asset mix to become less risky as your child approaches college age. That means you’ll start with a higher allocation to stocks (which have higher risk and higher returns), and will gradually tilt toward cash and bonds over time. The cash and bond portfolio is a more conservative portfolio as your child gets closer to 18 years old and begins college.
This automatic adjustment makes age-based tracks very popular among people who do not want the responsibility of personally managing the allocations in their 529 portfolio. You should seriously consider this approach.
The second option is called the “static” choice. You choose an investment fund or group of funds that maintains the same allocations over time. There are a number of allocations to choose from ranging from an all equity portfolio, a balanced portfolio, to an all bond portfolio. The allocations will remain until you decide to change them. This allows you to choose a portfolio based on your risk tolerance and need for growth.
Stocks are typically a riskier investment, but they have a higher expected return than bonds. Most bond categories are typically much less volatile but come with lower returns. However, all bonds are not the same. Certain categories, particularly high-yield bonds, deliver higher returns but can be more like stocks in their level of volatility. We avoid high-yield (junk) bonds for our clients.
With the ever-increasing price of tuition, the need to have your investments grow is crucial to offset the rising cost of a college education.
Originally published on MoneyTips.com by Dan Crimmins
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