How to Start a College Savings Plan

It’s the end of January, that time when your resolve may be starting to fade on those ever-hopeful New Year’s resolutions! What better time than now to add a new resolution—but one you’ll stick to throughout this year and the next 20. It may be time to start thinking about a college savings plan.

When you were in college or dental school, maybe you had some scholarships or grants. Or maybe you paid or are still paying those student loans. The cost of higher learning hasn’t gone down since your fraternity or sorority days. Quite the opposite, in fact. It may be time to start thinking about a 529 College Savings Plan.

529 plans aren’t your only savings option, but there are reasons they are increasingly popular. Unlike other educational savings vehicles and regular savings accounts, 529 plans give you control over your choice of investments and beneficiaries, plus the opportunity for tax-free earnings and withdrawals that are free from federal and some state income taxes.

As with all savings vehicles, time can work in your favor even if you don’t have a lot to contribute right now. The longer your time window before the money is needed, the longer you’ll be able to earn compound interest enhanced by federal tax-free growth potential. This is because any earnings in 529 plans are automatically reinvested in the plan.

Just about every state offers 529 plans and makes them available to both residents and non-residents. But your home state offers the best advantages of all—in many states and in the District of Columbia, 529 account holders have a full or partial state income-tax deduction, typically a dollar-for-dollar deduction based on your contribution. And there is at least one plan—the Private College 529 plan run by 279 private and college universities nationwide—that offers a prepaid tuition plan for all of those institutions. The private plan is unique in that it has no fees; the member colleges (which include institutions both large and small) pay all fees and bear all of the investment risk.

The Usual Caveats

Most 529 plans carry fees, which can include advisor fees, program management and maintenance charges, and underlying investment fees. You’ll need to do some research to find out what fee structure works for you. Also look into the investment choices your 529 plan makes, the performance of that investment strategy over time, and the long-term viability of the investment provider offering the plan.

As with any investment, there is a degree of risk. And the inverse relationship between risk and return is the same with a 529 plan as it is for any investment. A plan that invests very conservatively will have less risk but less potential return. Your time window, the number of individuals you plan to save for, and your overall risk tolerance should match the plan you ultimately choose.

Truly conservative investors who don’t mind a small rate of return should always be aware of the power of inflation to deplete your savings. Time windows work both ways: compounding interest means the potential for growth, of course, but if the fund’s return is really low over a 20-year period, your investment may not keep pace should the next couple of decades include a few periods of steep inflation. Talk to a financial advisor about your options if you are unsure how to proceed, and don’t hesitate to reach out to a tax advisor for more on the amount of your contributions, if any, may be tax deductible in your state.

Two other notes about 529 plans are worth mentioning. First, you are not locked into your choice of 529 plan. If the original beneficiary of your Pennsylvania-based plan suddenly falls in love with Beantown, every state allows a 12-month rollover to another 529 plan with no tax consequences, though you may be faced with a penalty. Second, if your beneficiary instead decides to follow her rock-and-roll-band dreams, you can change the beneficiary on your account to another child, grandchild, or another relative.

As a last resort, you can use the money from your 529 plan to upgrade your own skills by taking classes at a qualified college or trade school. Perhaps your sorority days aren’t over just yet!