A new study from Edward Jones reveals that Americans lack knowledge about the features and tax benefits offered by 529 plans. Few parents ranked saving for college as a top financial goal and 36% of parents do not save for college at all.
Lack of knowledge of 529 plan benefits
Two-thirds of Americans surveyed did not recognize 529 plans as an education savings tool, up 5 percentage points since the first survey was administered in 2012. Nearly half of those who are familiar with 529 plans did not know that 529 plans can be used to pay for K-12 education.
Money saved in a 529 plan grows tax-deferred, and can be withdrawn tax-free when used to pay for qualified education expenses, including up to $10,000 per year in K-12 tuition. Over 30 states also offer an additional state tax benefit for residents who contribute to a 529 plan.
Some parents hesitate to open a 529 plan because they believe they will lose all of their savings if their child wins a scholarship or decides not to attend college. However, only the earnings portion of a non-qualified distribution will incur income tax and a 10% penalty. The 10% penalty on non-qualified withdrawals is waived if beneficiary receives a tax-free scholarship. Therefore, in many cases taking a non-qualified 529 plan distribution is no worse than saving in a taxable investment account such as a mutual fund.
Competing financial priorities
Only 8% of Americans ranked paying for education as their most important financial goal. Other top goals included preparing for retirement (30%), preparing for the unexpected (24%) and living in retirement (21%).
Families with competing financial priorities may have trouble finding room in their budget for college savings. However, it’s important to start saving for college as early as possible. Even a small amount invested in a 529 plan each month will benefit from tax-free compounding and can reduce the amount the student will have to borrow.
529 plan account owners may set up automatic investments when they enroll in a 529 plan. Parents who use an automatic investment plan can potentially save more for college and minimize volatility with dollar-cost averaging. Minimum contribution requirements typically range between $15 and $25 when an automatic investment plan is used.
There are also ways to boost college savings without having to contribute anything out of pocket. Many 529 plans offer gifting platforms that allow friends and family to contribute electronically for birthdays, holidays, graduations and other occasions. Several credit cards offer cash back for college savings, and families who join Upromise earn rewards for shopping online and dining at participating retailers.
Parents leave themselves vulnerable
Personal savings accounts (38%), scholarships (35%), federal or state financial aid (33%) and private student loans (20%) were the most common ways families save for college, according to the survey. 529 plans (18%) were the least common savings vehicle, even though they are specifically designed to save for education.
For most families, a 529 plan is the best way to save for college. Most 529 plans offer greater return potential than a personal savings account, and 529 plan investment earnings are tax-free when the funds are used to pay for college.
Scholarships and financial aid may help cover a portion of future college costs, but it’s also important to save. A good rule of thumb is to aim to save one-third of total college costs and cover the remaining two-thirds with current income and student loans.
Families who primarily use a 529 plan to save for college can potentially save more for college over time. The more funds a student has available for college, the less they will have to borrow in student loans.