Why Saving for College Now and Considering 529 Plans Matters

Investing

Not sure which college savings plan is right for you?  See also NerdWallet’s Best 529 Savings Plans of 2013.

By Ashley Curtin

Many people tend to wonder why saving for college is important when they can just take out loans and pay them back later… right?  Today there are more and more reasons every day to start saving for college as soon as possible.  College is a gift of a life time; it opens doors to many job opportunities and the ability to become an independent person.  But if saving for college doesn’t start early, college can become an annoyance that many students will have to be paying for the rest of their lives.

According to the College Board, the average cost for tuition and at four-year public institutions has increased nearly 51% over the last 10 years.  In addition to this expense, it’s almost a guarantee that private schools are double the cost, and these costs will only keep rising.  Saving for college can help decrease the amount of loans students will need to take out, and also decrease the burden of all the debts they will be in.  It’s now beginning to be a common occurrence that students are more focused on the debt they are in from college more than their studies.  Isn’t the whole point of college to learn new things and get a degree?

Like any other big investment, the key to saving for college is to start early and save on a regular basis. By saving a set amount at certain times, the money you are setting aside can grow as your child does.  Although you may not be able to save the full amount of money needed to pay for a four year degree, saving early goes a long way. A family that begins setting aside $50 a month when their child is born can accumulate over $21,000, in an account that earns 7% interest per year, by the time the child turns 18 and is ready to head off to college.

A way to start putting away this money is to set up a 529 plan.  A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996. There are two types of 529 plans, prepaid plans and savings plans.

Prepaid Plans: Prepaid plans allow someone to purchase tuition credits at today’s rates to be used in the future. Therefore, performance is based upon tuition inflation.

Savings Plans: Savings plans are different in that all growth is based upon market performance of the underlying investments, which typically consist of mutual funds.

Another way to start saving would be to open a Coverdell Education Savings Account. A Coverdell Education Savings Account (ESA) is an account created as an incentive to help parents and students save for education expenses.

The total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary is someone who is under age 18 or is a special needs beneficiary. Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed.  The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.

As tuition increases it becomes more obvious that saving for college early on is becoming more important.  Not only will it take a huge amount of debt away, it will take a load off a student’s shoulders knowing they don’t have much debt to pay off once they leave college.

Disclaimer: This article is a part of NerdWallet’s series of user perspectives on 529 Plans.  The views and recommendations in this piece are held by the individual contributor and do not necessarily reflect the opinions of NerdWallet as a whole.