How to Deal with Rising Cost of College Tuition: The 529 Plan

The notion of the American Dream is grounded in the ideal of equal opportunity – that every American has the right to achieve his or her own aspirations and goals in the pursuit of happiness. For many, this boils down to getting married and raising a family, along with owning a home, a car or two, and the associated trappings.

The annual cost of the American Dream will vary by state, but for a typical family of four, that cost will range up toward the high-five figures. Included in the cost are necessary expenses – such as housing, food, transportation, child care and health care. What aren’t included are “wants” – things like vacations, restaurant meals, entertainment and…higher education.

That’s right – one of the biggest (if not the biggest) expenses – a college education – is omitted from consideration. Yet as many families are aware, putting aside money for college educations is both important and expensive. So, that does invite the question – Just how much does college cost for a family with two kids? Let’s take a closer look

It’s no secret that the average tuition cost among public and private institutions continues to rise at a steady pace across all demographics. A 2019 report based on data provided by The College Board indicated average costs for the 2017-2018 academic year of $25,290 for in-state colleges, $40,940 for out-of-state colleges and $50,900 for private colleges.

These are in-line with typical annual cost increases of 4% (public institutions) and 3% (private institutions). Almost 20 million students were projected to attend American colleges and universities in 2018 – so these numbers aren’t exactly based on a small sample size. Approximately one third of the 20 million students were matriculating at two-year institutions, which are generally less expensive than four-year institutions, and these accounted for the remaining two thirds of entering students.

Computed into the annual cost are tuition, room and board, books and supplies, transportation, as well as additional “other” expenses. While tuition costs do not vary widely by region across the United States, the very nature of whether a student is “in-state” or “out-of-state” plays a major role in annual tuition costs. Notably, the average cost for one year of in-state tuition was $9,970, while the average cost for one year of out-of-state tuition was $25,620.

If the American Dream represents the inalienable right to pursue happiness through the attainment of goals and aspirations – it sure looks like it can get pretty expensive in a hurry for a family with a couple of kids headed for college. Simple arithmetic – absent inflation – shows that a pair of four-year college educations can easily cost between $200,000 and $400,000.

This number can be lowered through need-based financial aid and scholarships, but not enough to prevent cost from being a major determinant in school selection for approximately 80% of families, according to a report by Sallie Mae.

With college costs continuing to creep higher while placing a strain on the typical American family, 529 College Plans have gained in prominence as a solution to the problem of funding the costs of higher education. So, what exactly is a 529 College Plan?

A 529 Plan is a tax-advantaged savings plan that encourages saving for higher education costs. Frequently referred to as qualified tuition plans, 529 plans are sponsored by individual states, state agencies and educational institutions, and are authorized under Section 529 of the Internal Revenue Code.

Investing in a 529 plan will generally impact a student’s ability to receive need-based financial aid, but it will almost certainly reduce the eventual amount of student loan debt. 529 plans fall under two headings – prepaid tuition plans and education savings plans. 529 Prepaid tuition plans allow a saver to purchase future credits at participating public and in-state colleges and universities at current prices for a beneficiary.

However, prepaid tuition plans typically are not designed to pay for future room and board expenses at educational institutions. Since most prepaid tuition plans are sponsored by state governments, they do have residency requirements for the saver and beneficiary.

Funds deposited into these plans are not guaranteed by the Federal government, but usually are guaranteed by State governments. However, if the sponsor of a prepaid tuition plan not guaranteed by the State government encounters serious financial difficulty, deposited funds could become at risk.

529 Education Savings Plans are investment accounts designed to save for a beneficiary’s future qualified higher education expenses including tuition, mandatory fees, as well as room and board. Withdrawals from education savings plan accounts can generally be used at any college or university within the United States, as well as some foreign colleges and universities.

Though all education savings plans are sponsored by individual state governments, very few have residency requirements for the saver or beneficiary. Investments held within education plans typically include mutual funds and exchange traded funds, with plans offering certain pre-set investment options that account holders can switch among only twice per year.

Any withdrawal not made for qualified educational expenses will be subject to taxes and penalties. Investments are not guaranteed by the Federal or State government, though some bank investment products held within education savings plans may be insured by the FDIC. As with any investment, there is no certainty of performance, and it is possible for an investor to lose some or all of the funds invested.

Investing in 529 plans offers tax benefits that include deducting contributions from state income tax, as well as matching grants – but eligibility for these will vary according to the specific plan and state – often requiring that the 529 plan is sponsored by your state of residence.

Importantly, one of the primary benefits of investing in a 529 plan are the tax-free earnings that can grow within the account over the course of many years.

The longer the investment period, the greater the opportunity for growth of tax-free earnings in the account. Earnings that are withdrawn from 529 plans and that are utilized for qualified educational expenses are not subject to federal income tax and often are exempt from state tax, as well. However, there are taxes and penalties for early withdrawals.

Finally, prepaid tuition plans and education savings plans come with application, enrollment, and ongoing administrative fees. Education savings plans will often come with asset management and annual account maintenance fees, as well.

Be sure to understand all fees associated with any 529 plan that you may choose, as these will lower your overall return. Regardless, 529 plans remain an excellent tool for any family looking to reduce higher education costs – especially when you consider that the cost of sending two kids to college for four years can run as high as $400,000 or more!

Steven Brachman is the lead content provider for UnitedSettlement.com. A graduate of the University of Michigan with a B.A. in Economics, Steven spent several years as a registered representative in the securities industry before moving on to equity research and trading. He is also an experienced test-prep professional and admissions consultant to aspiring graduate business school students. In his spare time, Steven enjoys writing, reading, travel, music and fantasy sports.

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