There is no better tool for most people than a 529 college savings plan to save for your children’s college. 529 plans are named after their section of America’s tax code. They were put into law in 1996 and provide parents with an excellent means to save for college. 529s allow parents to invest college savings in mutual funds and earnings accumulate tax-free as long as the money is used for educational expenses such as room and board, tuition, fees, books, and computers. Many state sponsored plans also allow the parents to receive a tax break on state income taxes.
According to the College Board, a not-for-profit association of more than 5,400 schools, colleges, universities, and educational organizations, the average price for a Private four-year college is $23,712 (up 6.3 percent from last year) and the cost for a Public four-year college or university in America is $6,185 (up 6.6 percent from last year).
According to Money Magazine, “70% of parents saving for college do not use 529s.” Like a Roth IRA, not using a 529 college savings plan can cost you thousands of dollars in unnecessary taxes. If you use only a regular taxable mutual fund to pay for your children’s college, you could be missing out on thousands of dollars in tax-free compounded interest that a 529 plan will earn.
For example, parents saving $200 a month for a child since his or her birth until the age 18, earning 8% interest per year can expect to have a 529 plan worth $96,657. The $53,457 earnings are tax free. If these parents were saving in a regular taxable mutual fund account, the investment would only be worth $81,689 after taxes, assuming the parents are in the 28% tax bracket.
Don’t believe me, you can see the math in an Microsoft Excel spreadsheet for yourself in Own The Dollar’s Resource Page.