529 College Savings Plan: The Best Choice for Any Income

Updated August 5, 2020
posted on 08-27-2019

Many parents want to get a jump-start on college savings, and the smartest strategy depends on a family's own financial situation. Whether you can afford to set aside $25 per month or $28,000 per child each year, one savings option offers a universal fit for most families -- the 529 college savings plan.

A 529 plan "offers flexibility of contributions but may also provide a meaningful part of substantial estate planning strategies as well as tax-free growth, and in some states, tax deductible contributions," said Suzanne Krasna, a certified financial planner and owner of Krasna Financial Group LLC in Walnut Creek, California.

That sounds pretty appealing if you want to be confident that you can afford to send your child to college.

Consider Your Financial Situation First

While a 529 plan isn't the best choice for absolutely every family -- because you should be fairly certain at least one of your children is going to college -- Krasna said it's important that your college saving strategy sits alongside other financial planning basics such as retirement, emergency savings, and short-, medium- and long-term savings goals.

"You must first ask yourself what your personal, professional and family goals are," said Krasna, who has worked with hundreds of families throughout her 30-year career. "All of these goals impact how you are going to focus on your savings and investments throughout your life."

Once a family has determined how much they can afford to put aside for college, Krasna said 529 plans are a great savings vehicle because their flexibility makes them well suited to a wide range of budgets.

529 Plans: The Savings Plan Versus the Pre-Paid Tuition Plan

It's important to know that there are two versions of the 529 plan: the college savings plan and the pre-paid tuition plan. With the savings plan, money is deposited into an account through which investments are made -- typically conservative mutual funds -- and the money can be used for higher education expenses, including tuition, room and board. The pre-paid plan is exactly what it sounds like: You pay up front for tuition only, and rates are locked in when you start saving.

With the continually increasing costs of higher education -- many financial experts assume an annual 7% inflation rate when calculating future college costs -- families should avoid putting college savings on the back burner. A four-year, in-state public college costs more than $10,000 per year, according to The College Board, while out-of-state and private schools range between $30,000 and $50,000-plus per year -- and those numbers will only go higher over time.

Whatever your income level, Krasna shares tips and scenarios that will help you make the most of a 529 college saving plan.

529 Plan Strategy for Lower Income Households

Families making just enough money to cover living expenses with a limited amount remaining for discretionary and savings could ultimately establish a 529 plan for each child but should start with the oldest first.

"If your savings dollars are really minimal, just get one 529 plan going," Krasna said. "Even if you have three children, you might focus on one 529 plan for your oldest child and over the next few years start one for the second and then later another for the third."

Hypothetical savings scenario for low-income families: Your first child is a 1-year-old and will start her education at a two-year public school 17 years from now, which has an estimated annual cost of around $3,000 today. Assuming a 7% annual inflation rate, the projected tuition cost when she is 18 years old would be $20,270.
Let's say you put in $1,500 to get a 529 plan started today. To cover 100% of the projected cost ($20,270), you would need to save $46.33 per month (or $556 each year) and earn a 5% annual rate of return to meet your goal of sending one child to a two-year junior college.

[See how much you could save over time with our Simple Savings Calculator.]

529 Plan Strategy for Middle Income Households

A middle income family could make higher monthly or annual contributions of $50 to $100 or more per child. Some families receiving inheritances might consider making lump-sum contributions to help cover any shortfalls in college savings. Grandparents or other family members may want to make substantial estate planning gifts by establishing a 529 plan themselves and naming their grandchildren or nieces and nephews as the beneficiaries.

Consider this hypothetical savings scenario for middle-income families: A family has two children, ages 6 and 2, and an income of $80,000. Let's say the relatives gift $2,500 for each child into a 529 savings plan, and the parent plan to deposit 10% of their annual income (that's $333 month per child) into each account from now until college. If they earned a 5% annual return within the 529 plans, that would be enough to give the 6-year-old $70,072 for college in 12 years and enough to give the 2-year-old $103,204 for college in 16 years.

How close would that put them? Assuming that the average four-year public college costs around $10,000 per year today ($40,000 total), and if tuition costs continue to rise by 7% annually, their college savings would grow to 76% of the total they would need ($92,429) for the 6-year-old and of 85% of the total they would need for the 2-year-old ($122,196). That would significantly cut the need for student loans in the future.

529 Plan Strategy for Upper Income Households

Families with higher incomes and greater assets could chose to make maximum annual gifts for each child's 529 college savings plan. If they planned to max out their annual gift contributions, each parent could put in $14,000 annually per child per year, or together they could contribute $28,000 per child per year. If the parents put in $28,000 on their child's first birthday and left it alone to grow at 5% per year that money would turn into $65,395 by the time they turned 18, which is around 50% of what they would need for a four-year public school.

Alternatively, for those with plenty of cash on hand, each parent could make a single contribution of $70,000 (the equivalent of $14,000 for five years) per parent per child, or $140,000 together per child without making any other contributions for five years. That could easily pay for a public university after 17 years with a 5% return (and assuming tuition growth stays around 7% annually).

For families that can afford to make high contributions, they make sense because unlike many other non-retirement savings accounts, a 529 college savings plan allows money to grow tax-free. In some states, contributions are tax-deductible, and 529 plans allow for tax-free withdrawals for college costs. Additionally, some estate-planning strategies could include contributions made to 529 college savings plans because they can considered as gifts that can reduce the value of a family's taxable estate.

Can you change the beneficiary on a 529 plan?

One of the biggest benefits of a 529 plan is that the beneficiary can be changed -- so if one child opts out of college, the funds can be transferred to another child. Another smart savings strategy for families trying to build a child's college savings? Encourage family and friends wanting to give toys and gifts to make contributions to the child's educational fund instead.

The takeaway is this: The sooner families start saving for college, the longer the power of tax-free compounding works for them. If college is in your child's future, 529 plans offer a simple, tax-efficient way to help families at all income levels meet future educational costs. Talking to a certified financial planner who specializes in working with families now will pay off in the long run by equipping you with a solid plan to achieve your savings goals.

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