College costs continue to climb despite public outrage over their egregious rate of inflation. The result? The student debt crisis is spreading. Americans now owe roughly $1.6 trillion in outstanding college loans, and not surprisingly, many are struggling to keep up with their payments.
It's for this reason that so many families are eager to save enough money to help put their kids through college. That way, their children can avoid the burden of massive student loans. Yet new data from Fidelity reveals that parents may not be saving for college all that efficiently. Specifically, only 23% say they own a 529 plan, which is one of the most effective educational savings tools out there.
If your goal is to put a child through college, it pays to consider a 529 plan. Here's why.
1. You'll get tax-free growth on your money
The money you contribute to a 529 doesn't go in tax-free as it would for a retirement savings plan like a traditional IRA or 401(k). But once you invest that money, it gets to grow tax-free, and withdrawals are tax-free provided they're used for educational purposes. This means that if you contribute $40,000 of your own money to a 529, and your investments allow that sum to grow to $60,000, you won't pay a cent in capital gains tax on that additional $20,000 if it's used for education.
2. You'll snag higher returns than a savings account will give you
You'll pay fees to set up and invest a 529 plan, which is a turnoff for some families. On the other hand, if you house your college savings in the bank, you generally won't be charged a thing. But even in a high-yield savings account, you're unlikely to snag a return on your money that's higher than 2%, whereas with a 529, you could easily see a 7% to 8% average annual return on your money, which is a bit below the stock market's average.
Here's why that makes a difference. Imagine you're able to set aside $200 a month for college over a 15-year period. At an average annual 2% return, you'd wind up with about $41,500. With a 7% average annual return, you'd be looking at $60,300.
3. You'll get more flexibility than you might expect
The problem with 529s is that you get penalized if you withdraw funds for non-education purposes (though to be fair, that penalty only applies to the gains portion of your account, and not your principal contributions). But on the flip side, 529s are fairly flexible. If the child you have your account earmarked for gets a massive scholarship, or decides not to go to college, you have the option to transfer that account to another child of yours or reserve it for future grandchildren if that's the route you want to take. Furthermore, changes to the tax code now allow you to use a 529 to pay for an elementary or high school education in addition to college.
Though 529 plans aren't perfect, they're a good bet if your goal is to amass a fair amount of money for college. If you don't have a 529, it pays to explore your options. Remember, you don't have to participate in your home state's 529 plan; you can put your money into any state's plan, so do some research and see which one is right for you.