Saving for College as Easy as 5-2-9

For many high school seniors, graduation is right around the corner. Spring is a good time for parents with children at any grade level to think about saving for college.

The average cost of tuition and fees in 2013-14 was $8,893 for an in-state, public university and $30,094 for a private one, according to The College Board. The trend of annual college costs outpacing inflation is expected to continue.

You have several options for financing your children’s education. One of the most popular is a 529 plan, named after that section of the IRS code. These qualified tuition plans allow you to save money for a child’s college or graduate school education in an individual investment account. They’re like a Roth IRA for college: Savers put after-tax dollars into the account, and earnings and distributions are income tax-free (as long as they’re used for higher education uses as defined by the IRS code).

Types of 529 plans

The two types of 529 plans are college savings and prepaid tuition. College savings plans are typically open to residents of any state, while prepaid tuition plans are usually limited to state residents. In addition, college savings plans don’t guarantee a minimum rate of return and can be used at any college in the country.

Prepaid tuition plans generally guarantee a minimum rate of return to ensure you keep up with college inflation. Essentially, you can lock in tomorrow’s tuition at today’s prices. The funds can only be used at participating plan colleges.

With 529 plans, you’ll want to consider four things:

• Diversification. Choose a plan with multiple investment options.
• Expenses. Most plans have them, so you’ll want to make sure the plan you choose is competitive.
• Time horizon. How many years you have until your child goes to college will affect what investments you choose.
• Risk tolerance. If your child is college-bound within the next few years, you won’t want to be as aggressive with your investments.

Start saving now

It’s best to start saving as soon as possible to take advantage of compounding. When your child is young, you have time to select investments that have the potential to outpace college cost increases. As your child gets older, you should consider selecting more conservative investments within the plan.

It’s not too late to open a 529 account even if your child is a sophomore or junior in high school. It might still make sense, because you’ll have a few years of potential tax-free growth on money. Be sure to check the plans, because some impose a minimum holding period before withdrawals can be made without penalty.

If your child is graduating soon and you already have a 529 plan, now is the time to review the terms, conditions and procedures of the plan. You’ll want to notify the administrator that your child will be making a withdrawal for college expenses. Make sure you understand how a withdrawal will affect your child’s income taxes and financial aid eligibility.

As with any investment, you should periodically review your 529 plan’s performance and your satisfaction with the investments. Take the time to understand your plan and weigh its expenses, tax benefits and performance record.