Avoid the College Debt Trap With This Savings Tool

Obtaining a college degree is one of the largest financial endeavors available to Americans. The cost of tuition rises on an annual basis at a pace that regularly exceeds broad inflation rates, while debt loads continue to grow larger with each graduating class. Saving ahead of time can help reduce the financial pressures of college, but many Americans are overlooking tools specifically designed for higher education expenses.

Student debt has become an epidemic in the current economy. According to a recent analysis by the Pew Research Center, nearly four in 10 U.S. households headed by an adult younger than 40 have student debt, representing the highest share on record. Households headed by a young, college-educated adult with student debt only have an average net worth of $8,700, compared to $64,700 to those with college degrees and zero student debt.

In order to help offset college costs and debt burdens, Americans should consider 529 savings plans, which are tax-advantaged investment plans to encourage saving for future higher education expenses. They are sponsored by states, state agencies, or educational institutions, and are authorized by Section 529 of the Internal Revenue Code. All 50 states and the District of Columbia sponsor at least one type of a 529 plan.

A 529 plan is relatively simple. The account holder establishes an account for the student (the beneficiary) and selects how contributions will be invested over time. In general, there are degrees of risk tolerances to choose from, and investment options often include stock mutual funds, bond mutual funds, money market funds, and age-based portfolios that become more conservative as the beneficiary nears college age. Account holders may change investment options once per year, and many plans have contribution limits in excess of $200,000. There are no income limits for account holders.

“They generally have a very low contribution cost. Most plans allow you to contribute as little as $50 per month in order to get started,” said Derek DeLorenzo, vice president at Ascensus College Savings, in a phone interview. “We stress with folks to start early and make contributions on a regular basis. Inside the plan, the account holder controls the assets so they decide how the money gets invested and how withdrawals take place. You can use money from your 529 plan to any eligible two- or four-year colleges, vocational schools, and technical schools.”

Americans do not have to select the 529 plan offered by the state they reside in, but there might be additional tax benefits if they do, as the majority of states offer a tax deduction on contributions. All 529 savings plans grow tax free from federal and state income taxes, and withdrawals are not taxed as long as the funds are used on qualified expenses, including tuition, room and board, mandatory fees, books, and computers. However, non-qualified expenses are subject to income taxes and a 10 percent penalty on the earnings.

While 529 plans count as parental assets in terms of financial aid eligibility, that is more favorable than having them count as student assets or income. Furthermore, 529 plans offer a significant amount of flexibility. If the child doesn’t attend college, the plan can be rolled over to another family member. Most states have no age limit for when the money has to be used.

Sallie Mae’s “How America Saves for College 2014” study revealed that 89 percent of parents value education as an investment in their children’s future, and 80 percent were willing to stretch themselves financially to save for the financial endeavor. However, 45 percent of parents were most likely to save for college in a general savings account, compared to 529 savings plans at only 29 percent. Saving for college is a top priority for families, second only to retirement.

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