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Discover Financial - Saving for College with a 529 Plan

Matt Hylland was recently quoted in an article for Discover Financial on saving for college using a 529 plan:

Matt Hylland, founder and financial planner at Hylland Capital Management in North Liberty, Iowa, says some families prefer 529 savings plans because they are able to save in small increments, unlike prepaid plans which typically require larger monthly installments.
"Savings plans also have the opportunity to generate higher returns so you will ultimately need to save less to pay for college," he says, compared to prepaid plans. "However, there is more risk in 529 savings plans if they are not invested wisely. If your account is heavily allocated to stocks and the stock market drops, you will likely lose some of your savings."
In that case, your 529 savings plan may not have enough assets to cover all of your child's higher education expenses, and you will have to cover the gaps. Some options include choosing a less expensive school, applying for financial aid and borrowing student loans.


You can read the entire article here: https://www.discover.com/student-loans/college-planning/529-plans.html

In addition to the topics covered in the Discover article, a few other basics on 529 college savings accounts:

529 Accounts and the New Tax Law

529 savings plans have received even more attention since the passage of the tax reform bill, which allowed 529 assets to be used for qualified expenses for elementary, middle, and high school as well.

Previously this benefit was only available to Coverdell Education Savings Accounts (ESAs).

The new tax law has made it so that the first $10,000 per year of private school tuition is essentially tax-free with proper planning. You can even set up multiple 529s, one for college expenses and another for earlier expenses to help plan for the future. 


Prepaid 529 Plans vs. 529 Savings Plans

Depending on your state, you may have a couple options when deciding how to fund your child's (or grandchild's, nephew/niece, etc) 529 account.

The traditional 529 account is a tax free "savings plan", where assets you contribute to the account grow tax-free. For most, this means adding assets over time, whatever amount you are able to afford to contribute every year. This type of 529 savings plan has some benefits:

  1. You are able to start saving with very little. For most states, it is around $25.
  2. Your savings can be invested in assets like stocks and bonds, which have the chance to appreciate over time.
  3. Depending on your state, contributions made to the account may give you a break on your state income taxes.

But there are some potential downfalls as well:

  1. Because your savings are usually invested in stocks and bonds, they have the potential to lose value as well. For those who have taken too much risk in their 529 investments, this may mean losing years' worth of savings if the market declines when you need to use the 529 money.
  2. Because of this, no matter how much you save, there is no guarantee that your contributions will pay for 100% of the education costs.

That's where the option of a prepaid plan comes in:

Prepaid 529 Accounts

With these accounts, you contribute a lump sum today that is guaranteed to pay for a certain period of time (such as a semester) at a qualifying institution in the future.

Not all states offer a prepaid plan. Iowa, for example, does not offer a prepaid 529 plan. Virginia does offer a prepaid 529 plan. Here is an example:


Depending on your child's age, you can prepay a set amount today to cover future costs. This type of plan has a couple advantages, and some disadvantages as well:

Advantages of a Prepaid 529 Plan

  1. Little risk. You have no worries about the stock market falling and its effect on your college savings.

Disadvantages of a Prepaid 529 Plan

  1. Expensive. Not all families have the ability to save a large lump sum required to prepay for a year or semester. 
  2. You lose tax benefits. States typically only offer benefits for a certain amount of contributions. For example, Virginia offers a tax break for the first $4,000 in 529 contributions each year. For those that take advantage of Virginia's prepaid 529 plan, they lose the ability to get a tax break on any contribution over $4,000.
  3. Inefficient. Unless college costs rise incredibly fast and the stock market performs very poorly, prepaid 529 plans are not an efficient use of your money.

For example, compare three different scenarios using our compound interest calculator:


Under Virginia's prepaid 529 plan, a parent of a 4-year-old today could pay $8,825 to pay for a semester of college in the future. Or, they could invest $100 a month into a 529 savings plan (likely much more affordable) and get an amount that should come pretty close to paying for a semester in the future. 

And saving higher amounts each month would pay for much more than a semester of college in the future. Like the other examples in the image above show, for a family that is in the early stages of planning, using a 529 savings account could be much more beneficial. 


College Planning

There is so much more to college planning than 529 accounts, enough to fill up a book.

And in fact, that is what we have almost done with our complete college planning series available on our website. If you are interested in reading more, check out our blog posts:

Part 1 - Early Stage College Financial Planning

Part 2 - Late Stage College Financial Planning

Part 3 - College Planning After Graduation

And of course, we are always here to help. Our first meeting is free! So let's talk and see how we can help you plan for college expenses


Matt Hylland