When should you start saving for college? As you look into the eyes of your newborn baby, thinking about college may be the furthest thing from your mind, which might already seem a bit cloudy due to lack of sleep. In truth, now is a great time to start saving.
Open a 529 Plan
Section 529 of the Internal Revenue Code defines a college savings plan sponsored in many states, including Iowa. The plan offers some significant tax advantages:
- Your investment in the 529 plan grows tax deferred from both federal and Iowa state taxes.
- In Iowa and some other states, you can also deduct contributions to the plan from your taxable state income. Each parent can contribute to the account, potentially doubling the amount of tax-deferred money invested.
- When you eventually use the funds for qualified educational expenses, withdrawal is completely tax free.
Who can Open a 529 Plan?
Anyone can open a plan and designate a beneficiary, with no limit on the number of plans that can be opened for an individual. This means that parents, grandparents and others can all open plans for the same person, making it a great gift idea for a young child who really doesn’t need more clothes or toys. In Iowa, you can deduct up to $3,239 in contributions per student or beneficiary from your state adjusted gross income (AGI) in 2017.
If you and your spouse both contribute to separate accounts for your children, you can each deduct up to $3,239 per child. If you have two children, your total possible deduction on your Iowa return would be $3,239 x 4 = $12,956.
In Iowa, you can continue to contribute to College Savings Iowa 529 accounts until the state tax filing deadline, typically April 30, 2018. Even if you need the money for tuition and eligible expenses later in 2018, you can still claim the state tax deduction for the contributions made for the 2017 tax year, through April 2018.
While you can contribute more than $3,239 for a child in a given year, remember that anything over that amount will not qualify for the Iowa state tax deduction. In addition, contributions in a single year that exceed $14,000 may impact gift taxes. If you or someone else wants to make a large contribution in a given year, it makes sense to consult a tax advisor.
What’s Better – Savings or Borrowing for College?
The earlier you start saving, the less you may need to borrow later on. When you look at the actual numbers, prioritizing college savings should pay off handsomely for you compared to taking out a student loan. The College Savings Iowa website gives an example that dramatically compares a savings plan to student loans later:
- Contribute $25/week for 18 years, assuming a 6% annual return. That generates $23,400 in savings, plus an additional $18,600 in earnings, for a total value of $42,000 available for college expenses.
- To borrow the same $42,000 at 7% for ten years, you would pay $16,440 in interest, for a total of $58,440.
- If you had saved the $23,400 in the plan, it would have cost less than half of the cost of a student loan when your child heads off to college.
Obviously, the example makes some assumptions about investment growth and loan interest costs, but the concept still applies. Saving now will cost far less than borrowing later, and you may have to do both.
You Can Use 529 Funds for More than College
While many people open accounts for future college expenses, your beneficiaries can use the money for postsecondary trade and vocational schools, too. They can apply the fund to eligible expenses for two-year and four-year colleges, plus postgraduate programs. If a beneficiary decided not to pursue education, you can transfer the funds to another beneficiary. In the most extreme cases, you can withdraw the funds, but you’ll pay a penalty, plus state and federal income taxes.
How Much Can You Afford?
With daily pressures on your income, you may be asking yourself whether you can afford that much out of your monthly budget. After all, you’re trying to put away money for retirement. You have a list of priorities and demands. Making a 529 plan a high priority can make a major difference in having funds available for your children’s education. Starting now at any level will benefit you in the long run. The sooner you begin, the larger the benefit.
Starting an account is easy. You only need an initial investment of $25 to open an account and can set up automatic withdrawals to ensure continued investment if you choose. While making steady contributions regularly provides one approach, you can choose to contribute less frequently and in various amounts.
Before deciding on which approach might work for you, it may help to consult your tax advisor. For more information on 529 plans, you may wish to review the College Savings Iowa website at https://www.collegesavingsiowa.com/. Also, you can contact us at TD&T and we will be happy to discuss the options available with you.