Lifestyle Tip #11: Save for College

11 save for college

Is it too late to start saving for college? And what’s the best way to do it? My friend Vaishali recently asked me this, and then suggested I turn my answer into a blog post. She’s usually right about such things, so here goes.

A popular and effective way to save for college is a 529 plan. It’s named after the section of the Internal Revenue Code that authorized it 20 years ago. Lindy and I have started a number of these through the years:

  • For her younger brother and sister, when they were school-aged
  • For each of us, when we went to graduate school
  • For XY, when we finalized her adoption in 2012

Basically, it’s a way to set aside money that has tax advantages when you put it in and when you take it out. Some employers have a matching program. Any friend or relative can make contributions. I believe a 529 is something every parent of a child who might go to college someday should use. But it’s clearly something that could use a little more publicity: I’m on the PTA board at XY’s school, and one of our most popular meetings last year featured a talk by a representative of Maryland’s 529 plan.

The original question

Vaishali was asking if it’s too late to start saving up for her 8-year-old son. It’s true we live in a metropolitan area where parenting can require a ridiculous amount of forethought. It’s not unheard of to put one’s name on a waiting list for daycare before trying to conceive or starting the adoption process. But it’s never too late to start a college savings account. In fact, Lindy and I were using our DC 529s as a sort of tax-preferred savings account when we were in graduate school in our 30s. We’d put the money in one month and withdraw it the next.

I advised that she and her husband each open up an account for their son’s benefit. I’d say the same for any two-parent household. As long as your high-interest debt is paid off and you have an emergency fund, it’s always best to take free money when you’re saving for the future. Tax benefits and a possible employer match = free money.

The tax benefits

In Maryland, you can deduct up to $2,500 a year for each account for each beneficiary. If each of you has an account, that’s up to $5,000 in deductions from your Maryland income taxes. This would be a monthly contribution of roughly $417 total. For an 8-year-old, you could run that through various online calculators and see how you end up after 10 to 14 years of savings.

The options

Maryland is actually one of the few states with two 529 plans: a prepaid college trust and a college investment plan. We picked the latter, and we transferred the assets from a similar plan we had started in DC when we moved to Maryland. It functions much like a tax-deferred retirement account at work: you can choose low-cost index funds or a special fund that is tied to your child’s anticipated year of graduation. The investment automatically becomes more conservative over time, like an age-banded retirement fund would.

The prepaid plan doesn’t actually require the kid to go to a Maryland school — it simply locks in what the tuition would cost if he or she did, and pays out the same amount of money to apply toward tuition elsewhere if not. We didn’t choose this one because you have to choose a given number of years of tuition to invest in, and XY’s ability to spend the money would be somewhat limited.

The college investment plan isn’t tied to Maryland schools at all. It’s just sponsored by the state of Maryland, and is the only plan in the country that will give you a Maryland tax benefit for participating. You are free to invest in any 529 elsewhere if it seems better — if the returns look better, if the fees look lower, if you are planning on moving — or you can just invest the money in some kind of mutual fund instead. We went with the MD 529 investment plan because it looked good. I asked around at work among the few dual-income parents I knew before signing up. I got a handful of blank stares and one friend who said she’s been advised just to invest taxable income for all purposes, which could include her child’s education or maybe not.

What now?

As for how much to save, I would go as close to the maximum tax deduction as you can and see where you end up. You can always do more, but there’s a certain school of thought that says you fully fund your own retirement first before putting too much away for college.

The money your son or daughter withdraws will be tax-free, as long as it’s for college expenses. If for some reason he or she doesn’t go to college, you can use it for either of yourselves or transfer it to another relative.

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