Saving for College: Why It Pays to Start Early
It's important to save for college in a way that maximizes your potential return and minimizes your tax liability
Next to buying a home, funding a child or grandchild’s college education may likely be your biggest expense—and the price is only getting higher.
According to the College Board, the total cost of a four-year private college education today averages just under $190,000; assuming costs rise by 3% a year, that number will swell to $323,000 by 2036, when a child born today enrolls as a freshman.
When it comes to covering education expenses, one option is to borrow the money through the use of student loans.
Another option is to utilize tax-advantaged investment accounts – like a 529 College Savings Plan. If you choose to go this route, the earlier you start investing, the better.
For one thing, small contributions, made regularly, can add up dramatically over time thanks to the power of compounding. What’s more, early in the savings cycle, you can benefit from the earnings potential of more aggressive investments, such as stocks, shifting to more conservative holdings—like bonds—as your beneficiary approaches college age.
And, of course, by not taking out a loan, you’ll avoid paying interest, which can easily double or triple your total outlay over time.
The case for 529 College Savings Plans
Of the various education savings vehicles available today, perhaps the best-known is a 529 College Savings Plan (529 Plan). Consider these advantages:
- Your money grows federal tax-free. While contributions to a 529 Plan are subject to federal income tax, the earnings on the money are not when used for qualified education expenses, enabling your assets to grow faster than taxable investments.
- No taxes on distributions. Any money you withdraw from a 529 Plan is tax-exempt as long as it goes toward qualified education expenses, such as tuition, room and board, books, computers and lab fees.
- State tax breaks. Many states allow you to deduct your contributions from state income tax. For example, Pennsylvania residents can deduct up to $15,000 annually in contributions per beneficiary—$30,000 for married couples filing jointly, provided each spouse earned at least $15,000.
- Superior flexibility. Anyone can contribute to a 529 Plan—parents, grandparents, aunts and uncles, even friends—and the money can be used at nearly any higher education institution in the world. There are no age or income restrictions—a big plus, since some education savings vehicles do impose such limits, thus capping the amount you can save.
- Generous contribution limits. Contribution limits vary by state, they are typically $300-400,000 or even higher, allowing you to accumulate most or all of the cost of a four-year education.
- You’re in control. You—not the beneficiary—decide when to take distributions, how much to take, and how the money is used (remember, distributions will be tax free if used for qualified education expenses). And you can change the beneficiary whenever you like, as often as you like, without penalty if changed to another qualifying family member.
- Your money remains accessible. If you need the money in the event of an emergency or financial shortfall, you can withdraw the funds and use them as you see fit. Keep in mind, though, that while your contributions won’t be taxed, the earnings on them will, and you’ll be subject to a 10% penalty. The same conditions apply if the beneficiary receives a scholarship and doesn’t need the money—but the 10% penalty will be waived.
Custodial Accounts: Another Way to Save
If you’re putting money aside for college, you may want to consider opening a custodial account—either instead of or together with a 529 Plan. It’s a bank or investment account that you manage for a minor under the Uniform Transfers to Minors Act.
As custodian, you have full control of the account and can make withdrawals of any size at any time to cover expenses for the child—not just college, but things like travel, summer camp, music lessons and clothes. There are no restrictions on how much you can put in or on who can contribute.
One caveat: All transfers into a custodial account are irrevocable—any money you put in belongs to the beneficiary, who assumes control at age 18 or 21 (differs by state) and can use the money as he or she chooses. Ideally, the beneficiary’s intentions will align with yours.
Talk to PNC
It’s important to save for college in a way that maximizes your potential return and minimizes your tax liability. PNC can help you decide if a 529 Plan is appropriate for you—and a good fit with your other financial goals.
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Important Legal Disclosures & Information
College Board: Trends in College Pricing (https://trends.collegeboard.org/college-pricing)
College Board: College Cost Calculator (https://bigfuture.collegeboard.org/pay-for-college/college-costs/college-costs-calculator)
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