September 20, 2013

Christine Fahlund Chris Fahlund, Ph.D., CFP®, is a senior financial planner and vice president of T. Rowe Price Investment Services.

Saving for college as early as possible can go a long way toward meeting the costs of higher education. And you may not have to do it alone.

Many parents are looking for ways to help their children afford the cost of college. An early start through a 529 college savings plan can help significantly, as you may benefit more from the compounding of any returns. And with 529 college savings plans, your saving strategy can also involve your extended family. "Even if you're already saving for college, don't overlook the role that grandparents and aunts and uncles can play," says Christine Fahlund, CFP®, a senior financial planner with T. Rowe Price. "In today's world, it increasingly takes a family pulling together to help with future college costs."

Using a family approach

"Many families are taking a multigenerational approach to college savings," Fahlund remarks. "Every little bit helps. For example, having one grandparent contribute $100 every month to a tax-advantaged 529 plan can boost the effects of compounding. Even with a modest 6% average annual rate of return, it could mean a potential $40,000 in additional savings after 18 years (excluding any account fees)." Unique to 529 plans is the ability to contribute up to five years' worth of gifts to one beneficiary in a single year, with the amount exceeding the annual gift tax exclusion carried over to the subsequent four years. In 2013, a friend or family member can contribute up to $70,000 in one year to a 529 account for one beneficiary and still qualify for the annual gift tax exclusion of $14,000 per recipient.

Choosing a plan

Contributing to a 529 plan offers tax-deferred growth potential, and, depending on the plan, contributions may be tax-deductible at the state level. For a beneficiary, any withdrawals used to pay qualified higher education expenses—such as tuition, books, and room and board—are free of federal income tax and may be state tax-free as well.

However, if the withdrawal is for nonqualified purposes, the earnings portion may be taxable and subject to a 10% penalty. Generally, there are no income limitations or age restrictions to contributing, and many state plans allow investment of more than $300,000 per beneficiary.

Some of the benefits of 529 plans include:

  • Savings can be used at nearly any college in the country, including vocational schools and some foreign institutions.
  • As the account holder, you—not the beneficiary—remain in control.
  • You decide how much to invest and which investment options to choose.
  • Once a year you can change the investment options and/or transfer your account to a different state's program.
  • You also decide when and if assets may be distributed from the account, regardless of whether they are qualified or nonqualified distributions.
  • If your beneficiary decides not to go to college, you can transfer the account to benefit a family member of the beneficiary. Most plans even allow you to reclaim the funds for yourself at any time for any reason. There could be tax consequences, however, so be sure to speak to your tax advisor first.

The plans vary from state to state, and each has somewhat different costs, investment options, and tax incentives. It makes sense to compare the 529 plans offered by your state against those offered by other states to determine which may be best for you. Says Fahlund, "The important action is to save—and to begin as early as possible."

Please note that a 529 plan's disclosure document includes investment objectives, risks, fees, expenses, and other information that you should read and consider carefully before investing. State tax benefits are generally only available to residents of that state. Earnings on a distribution not used for qualified expenses may be subject to income taxes and a 10% federal penalty. The availability of tax or other benefits may be conditioned on meeting certain requirements such as residency, purpose for or timing of distributions, or other factors, as applicable.