529s: College saving made simple

Posted by on May 27, 2011 @ 2:04 pm in Personal finance

I recently overheard a remarkably in-depth discussion between two moms who were debating the features of several fairly expensive baby strollers. As the mom of two children, a toddler and an infant, I’ll sheepishly admit that I spent a ridiculous amount of time researching which double stroller to purchase. In hindsight, I spent too much time and too much money on the decision. (I’m even more embarrassed to think about how few times my kids have actually used their fancy double-wide ride.) I’ve probably wasted countless precious hours on decisions that seemed important at the time—but just weren’t important in the grand scheme of things.

I did at least one thing right, however. Perhaps because I work for Vanguard, I opened 529 accounts for both of my kids well before their first birthdays.

Sunday, May 29 is 529 College Savings Day, which presents a fitting opportunity to highlight one of the truly important decisions you can make for your child’s future. And because all parents are busier than we’d like to be, I’ll keep the key considerations simple:

Start early and save often.

If you take away nothing else, know this: starting early matters. There are plenty of calculators online to help you determine how much you need to save for college; you can check out Vanguard’s calculator. That said, no matter what number you have in your head, it probably isn’t enough. Did you know that your child’s freshman year at Harvard might cost $144,783 in 2029? To foot that bill for four years, you’ll need to set aside more than $1,400 per month from birth through age 21.

Feeling sick yet? That’s why starting early matters. To be fair, Harvard is an extreme example. So, don’t throw in the towel yet—the current statistics for most colleges aren’t quite as daunting. The average annual tuition/room-and-board for a four-year public institution runs between $16,000 for in-state students and $28,000 for out-of-state. For four-year private institutions, it’s in the $37,000–$46,000 range. Expensive, but not impossible.

Making college savings a regular habit is just as important as getting an early start. To fully bear the costs of sending your daughter to the average four-year state school, you’ll need to save $467 per month for essentially 21 years. That can feel like an insurmountable task, especially if you’re juggling multiple financial priorities. (And let’s face it, aren’t we all?) But, delay until she turns five, and the number jumps to $520 per month. Wait until she’s 10 and you’ll need to sock away $631 per month. You get the idea.

It may seem insignificant, but saving even $50 a month now—and ratcheting that up when your budget allows—will help. It might not pay for Harvard, but the power of compounding is on your side. Ultimately, be proud of whatever amount you accumulate. Over time, every dollar you save for college now amounts to that much less that you (or your daughter) will need to borrow in the future to cover college expenses.

Pay attention to fees.

You’ve heard it from Vanguard before, but it bears repeating: All else equal, lower investment costs can translate into better returns over the long run. That’s as true for college savings as it is for retirement.

Costs for a 529 account can vary widely, with expense ratios ranging anywhere from 0.25% to 2.05%, according to Savingforcollege.com. And there may or may not be tax benefits associated with the plan offered by your state. For example, I live in Pennsylvania, which happens to offer a state tax benefit regardless of which 529 plan I’m invested in. (Not sure about your state? This comparison tool can help.)

Once you narrow your 529 plan options, be picky about costs. Remember that modest $50 per month you’re going to invest in your child’s 529? According to Vanguard calculations, if you choose a plan with an expense ratio of 1.5%, your accumulated savings after 18 years, assuming a 5% gross return, would be just over $15,000. Invest that same $50 in a plan with an expense ratio of 0.25% and your savings top $17,000.* When you’re able to bump that monthly investment to $100, the difference in expense ratios only becomes more meaningful over time.

Make it easy on yourself.

It’s hard enough to carve out the monthly savings, you might want to make the process easier by selecting a 529 plan that offers investments that adjust automatically with your child’s age. This “age-based portfolio” concept is a simple one, but its simplicity is brilliant. The younger your child is when you open the 529 plan, the more heavily the portfolio is allocated to stocks. As your child approaches college age, the portfolio becomes increasingly more conservative to protect against loss. Choose wisely up front and you won’t need to worry about rebalancing your child’s 529 account over time. (Many 529 plans also offer the ability to specify a risk tolerance in conjunction with the age-based portfolio feature.)

Saving for college can feel like an overwhelming proposition for many of us. But breaking the long-term goal into smaller, more manageable tasks can help keep things in perspective. First, start as early as you can with as much as you can. Put time on your side and commit to bumping your savings goal up a bit each year. Next, consider selecting a 529 plan that couples low overall costs with an age-based asset allocation (and perhaps a tax break to boot).

Lastly, give yourself a break. Saving $50 or $100 a month may feel like a useless drop in a massive bucket, but it’s a good start. I’m betting your kids will thank you for the effort … eventually.

* This hypothetical calculation does not represent the return on any particular investment.

Notes:

• All investments are subject to risks.

• Past performance is not a guarantee of future results.

For more information about any 529 college savings plan, contact the plan provider to obtain a program description, which includes investment objectives, risks, charges, expenses, and other information; read and consider it carefully before investing. If you are not a taxpayer of the state offering the plan, consider before investing whether your or the designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Vanguard Marketing Corporation serves as distributor and underwriter for some 529 plans.

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