To help these families, we've listed six common ways you can save for college, and the biggest pros and cons of each:
The Medium column assumes a $15,000 annual contribution every year until 18 with a 6.2% compound annual return. The goal is to have saved $500,000 per child by the time he or she begins college. After age 18, $100,000 a year is to pay for college until the 529 plan goes to 0 at age 25.
If assets in a 529 are used for something other than qualified education expenses, you'll have to pay both federal income taxes and a 10 percent penalty on the earnings. (An interesting side note is that if the beneficiary gets a full scholarship to college, the penalty for taking the cash is waived.)
Many people saving for college choose 529 plans as their investment vehicles, and that's for good reason. 529 plans offer tax advantages that can help you allocate even more dollars to education expenses. There are a variety of plans available, and you're not limited to just your own state's plan.
In Sallie Mae's 2018 “How America Saves for College” survey, parents predicted savings would cover 29% of their child's college costs on average. If you plan for savings to pay for 30% of your child's four-year college attendance, in our example from above, that would be about $47,520.
A 529 plan could mean less financial aid.
The largest drawback to a 529 plan is that colleges consider it when deciding on financial aid. This means your child could receive less financial aid than you might otherwise need.
Roth IRAs
Another 529 alternative to put away money for college and invest it for a potentially larger return is to utilize an account intended for retirement, such as a Roth IRA. Roth IRAs are individual retirement accounts that allow people to save and invest after-tax money.
True or false: I will lose the money if my child doesn't go to college or gets a scholarship and doesn't need all the money. False. You don't lose unused money in a 529 plan. ... You can withdraw the amount of any scholarship awards from your 529 without penalty; federal and state income taxes on the earnings still apply.
In most cases, your 529 plan will have a minimal effect on the amount of aid you receive and will end up helping you more than hurting you. There are also several steps you can take to increase your child's eligibility for student financial aid.
You can fund education for other beneficiaries or withdraw the money entirely. Withdrawals from a 529 account for qualified higher education expenses are free from federal (and possibly state and/or local) income taxes.
Having multiple 529 plans is a good fit for some families, while others find that just one plan suits their needs better. When planning out your college savings strategy to include 529 savings accounts, keep one more thing in mind: what you'll do with any leftover money if your children don't use it all for college.
It's hard to find a perfect savings vehicle. But saving money imperfectly is still much better than not saving at all. On the one hand, 529 money will be counted against your child's financial aid. On the other hand, the 529 plan offers tax savings and control.
Parent-owned 529 plans, however, are not considered income to the student, but rather assets set aside for education. Because of this distinction, grandparent-owned 529 plans can reduce the amount of financial aid that a student is able to receive.
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