Do you love May? So many things to celebrate: Mother’s Day, Memorial Day, Star Wars Day, 529 Day, Lost Sock Memorial Day (5/9…yes, that is a thing). Wait, back up. Did you not know about 529 Day?! Honestly, we’re not totally surprised.
While we may never shoot fireworks in honor of 529 Day, it is a chance every year to spend some time talking about the importance of saving for college and to answer the question…is it better to save a dollar or borrow a dollar?
(It also a good time to take advantage of special sweepstakes and incentives held during the month by various state 529 plans. If you don’t see a plan on the list, Google it. Click here to see Ohio’s.)
529 plans provide a tax friendly way of saving for a child’s education. Earnings in a 529 grow federal tax-free. When money is withdrawn to pay for qualified college expenses, families will not be taxed on what they contributed or the growth of that money. Other types of saving accounts are subject to income taxes and capital gains taxes.
States also encourage their families to save for college. Over 30 states offer tax deductions or credits for 529 contributions. In Ohio, contributions up to $2,000 per beneficiary per year are tax deductible (if invested in the Ohio plan).
529 plans are flexible and low maintenance. Here’s what we mean:
- Families can choose any state’s plan they want. It doesn’t have to be the state they reside in, but be careful to check with their state for any tax benefits for contributing to their resident state’s plan.
- The owner of the account controls all distributions from the account. If the beneficiary chooses not to go to college or does not need the money, the owner can change the beneficiary and use the money for qualified college expenses for any relative they choose or even for themselves.
- 529 plans do not have any income or contribution limits. A household income does not impact the amount an owner can save, and they are not limited by an annual contribution maximum. (It should be noted that the 529 does not have an annual contribution limit, but the annual gift tax exclusion of $14,000 per donor in 2017 should still be considered. Most plans even allow an advanced 5-year gift of up to $70,000. An owner is limited over the life of a 529 plan to a total maximum aggregate limit that varies based on your state. Ohio’s current limit is $426,000.)
- After a plan is set up, contributions can be automated, and an owner can select an investment plan based on the age of their child that adjusts to an appropriate mix of investments, as college gets closer. Think of it as a crock-pot for investments. An owner should check in occasionally, but no need to stir it up all the time.
- Most states offer a “direct” to consumer plan with relatively low fees (but be sure to pay attention to what they are at sign up. If the plan is sold by an advisor be sure to ask what the commission is and how that can impact the overall investment).
- Family members and friends can invest too.
Qualified expenses include tuition, room and board, required fees, books, supplies, and equipment (including computers). Tuition, fees, and books are also included for part time students. Room and board is included for part time students who are enrolled in half time or more.
Is it better to save or to borrow? A dollar invested is worth more than a dollar because of interest, and of course a dollar borrowed costs more than a dollar because it is also subject to interest.
Say a family started investing $25 per week after their baby was born for the next 18 years for a total contribution over the 18 years of $23,400, assuming a 6% interest the family will have saved $42,095 due to compounding interest and the time value of money. If they were to borrow $42,095 as a student loan with 6% interest over a 10-year repayment period, they will have paid a total of $56,081 when factoring in principal plus interest.
The $23,400 you invested provided you with $18,695 in investment gains for a total of $42,095 to pay for college. Borrowing that same $42,095 to pay for college will cost you $13,986 in interest and a total of $56,081. Which sounds like a better deal…$23,400 or $56,081?!
We like to say that it is never too early AND never too late to save for college in a 529 plan. The danger lies in not doing anything.