The bad news: There’s no sign the trend of rising college costs will slow down any time soon. The good news: Parents are saving more for their children’s future college expenses than they have in years.
According to a new Sallie Mae and Ipsos survey, 56 percent of parents with children under 18 say they are saving for college, and, on average, have amassed a total of $18,135 for future expenses. That’s the highest level since 2013, and 11 percent higher than in 2016. Unfortunately, while Americans are saving more for college, 65 percent of savers surveyed say they are holding future tuition cash in old-fashioned savings or checking accounts. But by tucking money into these low- or zero-interest accounts, that tuition nest egg could be losing value in the long-run.
Here’s why: Average tuition expenses rose 3.6 percent between the 2016-17 and 2017-18 school year. Let’s say you put $10,000 into a savings account earning 0.18 percent in interest (the national average) annually. After one year, you’d have $10,018. But tuition costs rose 3.6 percent in that year, which means you would need to have $10,360 in savings to just to keep pace with rising prices. If tuition costs continue growing at a faster clip than your savings, every dollar you hold in that savings account is buying fewer books and lab fees down the road.
So, what’s a thrifty parent of a future honor student to do? You may want to consider a 529 college savings plan, which comes with tax advantages that you won’t get with traditional savings accounts or investments.
BENEFITS OF A 529 COLLEGE SAVINGS PLAN
A 529 plan is a tax-advantaged savings vehicle that’s sponsored by states, state agencies or educational institutions. When you contribute to your 529, that money is invested in underlying mutual funds or exchange traded funds and grows tax-free — sort of like a retirement account. Your state’s 529 plan might even offer full or partial state tax deductions as the money goes into your 529, but again, this varies by state.
Typically, the money will be placed in target-date funds that adjust the asset mix as your child gets older. For example, if you’re starting to save for a newborn, your money will be funneled into aggressive growth funds to hopefully rake in gains early in their life. As their first year on campus draws closer, the allocations gradually shift to a more conservative mix to shelter those funds from market gyrations.
When it’s time to start paying for school, withdrawals from a 529 are also exempt from federal taxes and most state taxes (it varies by state), so long as they are used for “qualified higher education expenses,” which include tuition, books, fees, housing and technology.
HOW TO START A 529
Fortunately, one-third of the parents surveyed by Sallie Mae and Ipsos are putting their savings to work in 529 plans, and have many reasons (and growing) to celebrate every year when National 529 Day rolls around. But if you’re just starting to accumulate money for your youngster’s education, or are already setting some aside in a savings account, it’s not too late to explore setting up a 529 plan of your own. If you’re having trouble getting started, a financial planner or professional can help you look at options that make the most sense for your situation.