Cradles Today, College Tomorrow

The cost of college education can be intimidating for new parents. But parents of newborns and young children may have time on their side.

 


Newborns—the joys are limitless. Tiny fingers. Toothless smiles. The intoxicating new baby smell. But first-time and veteran parents alike know that limitless anxieties come along with having a new baby, too. One particular worry that looms large for today’s parents is the cost of college.

Tuition, room, and board today can cost anywhere from $20,000 to upwards of $60,000 at a four-year institution.1 Who knows what it will be 18 years from now? And with student debt in America totaling upwards of $1 trillion,2 how could new parents not be nervous?

The best way to save for your child’s college education? Start early.

 

Invest Early, Invest Often

Parents of newborns and young children have one huge advantage when it comes to contributing to a 529 plan: time. This is the most valuable asset out there when it comes to long-term investments. By investing in your child’s education when he or she is still young, you have a large window of opportunity to capitalize on the “magic” of compound interest. Even investing a modest sum may set your child up for success (after all, you have bibs and pacifiers and diapers—so many diapers!—to buy).

For example, if you invest $200 per month from the time your child is born until the day she turns 18, you will have accumulated more than $77,000, assuming a 6% rate of return. Comparatively, if you begin investing $400 monthly beginning when your child is 10 years old, you will have amassed about $49,000. Investment returns are not guaranteed, and you could lose money by investing in a 529 Plan.

 

Less Can Be More if You Start Early On

This hypothetical illustration is not intended to reflect the performance of the any particular 529 plan or its investment options, whose actual rates of return will fluctuate.

 

The earlier you start, the better off you’ll be. Although you may feel it’s difficult to contribute much right now, setting up a plan, putting in whatever you can, and doing so consistently is what matters. Consider setting up automatic recurring payments online.3 It’s always possible to contribute more later, but in order to take advantage of compound interest, investing now is more important than investing big.

For every birthday from one to 18, family members will be texting you to ask what your child would like as a gift. Sure, you could tell your sister that your son loves Sesame Street. You could tell your mother-in-law that your daughter can’t get enough of Legos. Or, you could ask your family to make contributions to the 529 plan you have set up for your child.

If you have a particularly generous relative (or if you come into an unexpected windfall), there is a tax provision for 529 plans that allows for five years of allowable contributions to be made simultaneously, exempt of gift tax.4

 

What Is a 529 Plan?  

  • A 529 plan is a state-sponsored, tax-advantaged savings account that grows tax free.
  • The account owner retains control over the account, even after the beneficiary reaches 18. Beneficiaries can be changed or transferred easily.
  • Effective January 1, 2018, as part of the Tax Cuts and Jobs Act, up to $10,000 per student can be withdrawn annually to pay for private K-12 education.*
  • Fees and expenses vary by state, as do tax advantages. 
  • Returns are not guaranteed, and you could lose money by investing in a 529 plan.

 

* Qualified-expense status varies by state for withdrawals used for K-12 education. Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal income tax penalty.

 

Make it a Family Affair

Perhaps grandparents are considering opening up a 529 to benefit your child. More than one 529 plan may be opened for your child’s benefit, but do your due diligence. A 529 plan opened by a grandparent or relative does not count toward the student’s Free Application for Federal Student Aid (FAFSA). This means that distributions from these 529s will count as income for the student, impacting aid eligibility, possibly significantly.

On the FAFSA, student income is assessed at 50%. What does that mean for your child? Well, if $3,000 is withdrawn from this relative-owned 529, the beneficiary’s aid eligibility will decrease by $1,500 for the following year. There are two options in this case. Either the grandparents can transfer ownership to you before your child reaches college age or your child can cash in on these 529s later in their college careers, once all their FAFSAs have been filed.5

 


But, What if Baby Is a Genius? A Star Athlete? The Next Iron Chef?

College Board, Trends in Higher Education, 2017-18
 

 

But, What if Baby Is a Genius? A Star Athlete? The Next Iron Chef?

If your child receives a healthy scholarship, worry not. According to the IRS, the beneficiary can still withdraw money equal to the amount of the scholarship from the account without penalty (though earnings will be subject to income tax). Or, the assets can be put toward graduate school and advanced degrees in the future.

Also, there is no need to worry that you’re predestining your child to academia by setting up a 529 plan. Qualified education expenses include not only tuition, fees, and supplies at four-year colleges and universities, but also tuition and associated expenses of two-year colleges, vocational and technical schools, culinary school, and even some foreign universities.


Average cost of books and supplies for a full time student in a 4-year undergrad program is

Source: College Board, 2017


Qualified Education Expenses

college building Tuition and fees at colleges, universities, vocational schools, or other postsecondary educational institutes
books Books, supplies, equipment
handicap symbol Expenses for special needs
house keys Room and board
computer Computers, software, and Internet


Source: College Board, 2017


Use it or Lose it?

Another option for any money that may linger in a 529 after a child’s graduation is to take advantage of the tax-free beneficiary transfer capability. Remaining assets may be used for your other children.

Funds may also be rolled over, without tax consequences, to relatives of the beneficiary that include but are not limited to: siblings, children, in-laws, spouses, and first cousins. Per the IRS, you can even make yourself the beneficiary.

529 plans never “expire” either. There is no limit on the number of times the beneficiaries can be changed over the lifetime of the account. If there is no one in your family you would like to roll the account over to after your child’s graduation, you can transfer the account to her for her own children or grandchildren one day.

The bottom line is it’s pretty hard to contribute too much to a plan so flexible.

529 plans are advantageous to anyone seeking to pay for education, whether it be for herself, a high school cousin, or her fourth grade son. However, their potential is greatest when they are established early in the beneficiary’s life, creating ample opportunity for compound interest to grow investments of any size. Consult your financial advisor to make the most of your 529 plan.

Collegeboard.org, 2017

2 Forbes, “Student Loan Debt In 2017: A $1.3 Trillion Crisis,” 2/21/17

Continuous or periodic investment plans neither ensure a profit nor protect against a loss in declining markets. Because these programs involve continuous investing regardless of fluctuating price levels, you should carefully consider your financial ability to continue investing through periods of fluctuating market prices.

4 If the donor elects to treat a gift as being made over five years, and the donor dies prior to the end of that five-year period,the portion of the gift allocable to the period after the donor’s death will be included in the donor’s estate. Estate-tax treatment may differ by state. Any additional gifts to the same Designated Beneficiary in that five-year period would be subject to federal gift tax. Please consult your tax advisor for more information.

5 FAFSA.ed.gov, 2017

Investing involves risk, including the possible loss of principal. This information should not be considered investment advice or a recommendation to buy/sell any security.  In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice. This material may not be copied, photocopied or duplicated in any form or distributed in whole or in part, for any purpose, without the express written consent of Hartford Funds.

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