Avoid These 5 Costly Mistakes When Saving for College with a 529 Plan

The importance of saving for college

As a parent, one of my primary goals is to provide my children with the best possible education. However, the rising costs of higher education can make this dream seem daunting. That’s why it’s crucial to start saving for college early and to do so in a smart and efficient manner. One of the most popular and effective ways to save for college is through a 529 plan, but there are some common pitfalls that can derail your savings efforts. In this article, I’ll guide you through the top five mistakes to avoid when saving for college with a 529 plan.

What is a 529 plan?

Before we dive into the mistakes, let’s first understand what a 529 plan is. A 529 plan is a tax-advantaged investment account designed specifically for saving for future education expenses. These plans are sponsored by states, state agencies, or educational institutions, and they offer various investment options to accommodate different risk tolerances and time horizons.

The primary benefit of a 529 plan is that the money you contribute grows tax-deferred, and withdrawals are tax-free when used for qualified education expenses, such as tuition, fees, books, and room and board. Additionally, some states offer state tax deductions or credits for contributions to their 529 plans.

Common mistakes to avoid when saving for college

Mistake #1: Not starting early enough

One of the most significant mistakes parents make when saving for college is not starting early enough. The power of compound interest is a powerful ally when it comes to growing your savings, but it only works if you give it time. By starting to save as soon as possible, even with small contributions, you can take advantage of the compounding effect and potentially accumulate a substantial amount by the time your child reaches college age.

Here’s an example to illustrate the impact of starting early:

• If you start saving $100 per month when your child is born, assuming a 6% annual return, you’ll have approximately $40,000 by the time they turn 18.
• However, if you wait until your child is 10 years old to start saving the same $100 per month, you’ll only have around $16,000 by the time they’re 18.

The earlier you start, the more time your money has to grow and the less you’ll need to contribute each month to reach your savings goal.

Mistake #2: Not saving enough

Another common mistake is underestimating the actual cost of college and not saving enough to cover those expenses. College costs have been rising at a rate that outpaces inflation, and it’s essential to factor in not just tuition and fees but also room and board, books, transportation, and other living expenses.

According to the College Board, the average cost of tuition and fees for the 2022-2023 academic year was:

• $10,770 for in-state students at public four-year institutions
• $28,660 for out-of-state students at public four-year institutions
• $39,810 for private non-profit four-year institutions

These costs don’t include room and board, which can add an additional $12,000 to $15,000 per year, depending on the institution.

To avoid falling short, it’s crucial to estimate the total cost of attendance for the colleges your child is interested in and set a savings goal accordingly. Many financial advisors recommend saving at least one-third of the projected total cost if you start saving when your child is born.

Mistake #3: Not understanding the tax benefits of a 529 plan

One of the primary advantages of a 529 plan is the tax benefits it offers, but many parents fail to fully understand and take advantage of these benefits. Contributions to a 529 plan are not deductible from federal income taxes, but the money grows tax-deferred, and withdrawals are tax-free when used for qualified education expenses.

Additionally, many states offer state tax deductions or credits for contributions to their 529 plans. For example, in New York, residents can deduct up to $5,000 (or $10,000 for married couples filing jointly) from their state income taxes for contributions to the New York 529 plan.

It’s essential to research the tax benefits offered by your state and factor them into your savings strategy. Failing to do so could mean leaving money on the table and missing out on valuable tax savings.

Mistake #4: Choosing the wrong investment options

When you open a 529 plan, you’ll typically have several investment options to choose from, ranging from age-based portfolios to individual mutual funds or exchange-traded funds (ETFs). Choosing the wrong investment options can significantly impact the growth of your savings and your ability to meet your college savings goals.

Age-based portfolios are a popular choice for many parents as they automatically adjust the investment mix from more aggressive to more conservative as your child gets closer to college age. This approach can help manage risk and protect your savings as you near your goal.

However, if you have a higher risk tolerance or a longer time horizon, you may want to consider more aggressive investment options, such as equity funds or a mix of stocks and bonds. Conversely, if you’re closer to your child’s college years, you may want to shift to more conservative options, like fixed-income funds or money market accounts, to preserve your principal.

It’s essential to understand your risk tolerance, time horizon, and investment objectives before selecting your investment options. Additionally, regularly reviewing and rebalancing your portfolio can help ensure that your investments remain aligned with your goals.

Mistake #5: Not adjusting your savings strategy as your child gets closer to college

As your child gets closer to college age, it’s crucial to reevaluate your savings strategy and make any necessary adjustments. This may involve shifting to more conservative investment options to protect your principal or increasing your monthly contributions to make up for any shortfalls.

Additionally, as your child approaches college, you’ll need to start researching and applying for financial aid, scholarships, and other forms of assistance. These can significantly impact the amount you’ll need to contribute from your 529 plan savings.

Failing to adjust your savings strategy as your child gets closer to college can lead to either taking on too much risk with your investments or not having enough saved to cover the full cost of attendance.

Tips for successful college savings with a 529 plan

Now that we’ve covered the common mistakes to avoid, let’s explore some tips for successful college savings with a 529 plan:

1. Start early: As mentioned earlier, the earlier you start saving, the more time your money has to grow through compound interest. Even small contributions can add up significantly over time.
2. Set realistic goals: Estimate the total cost of attendance for the colleges your child is interested in and set a savings goal accordingly. Be sure to factor in not just tuition and fees but also room and board, books, and other living expenses.
3. Automate your contributions: Set up automatic monthly contributions to your 529 plan to make saving a habit and ensure that you’re consistently contributing to your child’s education fund.
4. Take advantage of tax benefits: Research the tax benefits offered by your state for contributions to a 529 plan and factor them into your savings strategy.
5. Diversify your investments: Consider a mix of investment options, such as age-based portfolios, mutual funds, and ETFs, to diversify your portfolio and manage risk.
6. Review and rebalance regularly: Periodically review your investment performance and rebalance your portfolio as needed to ensure that your investments remain aligned with your goals and risk tolerance.
7. Explore other funding sources: In addition to your 529 plan savings, research and apply for financial aid, scholarships, and other forms of assistance to help cover the cost of college.

Conclusion: Start saving for college the right way

Saving for college is a significant financial commitment, but with proper planning and a strategic approach, it’s achievable. By avoiding the common mistakes outlined in this article and following the tips for successful college savings, you can put yourself and your child in a strong position to tackle the rising costs of higher education.

Remember, the earlier you start saving, the more time your money has to grow, and the less you’ll need to contribute each month to reach your goals. So, don’t wait – start saving for college today and give your child the gift of a solid educational foundation.