What's up with 529 college savings plans? On paper, these investment vehicles should be a smashing success--after all, they're generally recognized as the best way to save for a child's college education thanks to their generous tax breaks. Yet various surveys show that many parents have done a poor job saving for college, in part because 529 plans are misunderstood and underutilized. Throw in a lousy economy and rocky days on Wall Street, and 529 plans recently are taking a hit just like most other investments.
According to Financial Research Corp., assets in 529 plans declined during this year's first quarter, marking the first time that's happened since the company began tracking 529s in 2001. Total assets fell to $108.7 billion during the quarter, a 2.9% drop from the fourth quarter (and a 0.7% drop from the third quarter). And the estimated net sales of $2.2 billion in the first quarter were less than half the $5.2 billion total from the same period the year before.
"A lot of parents view college savings as discretionary spending," says Tom Kazmierczak, senior product manager for 529s and college savings at T. Rowe Price. "Rising gas prices and other expenses take precedence over saving for something they won't use for maybe 10 or 15 years."
That might seem surprising given that a college education is one of the pillars of the American dream. But a survey done last October by The Hartford Financial Services Group showed that 43% of parents hadn't started saving at all for college, and that 70% of parents who had started saving weren't using 529 plans.
"No one comes in here and asks for them [529 plans]," says Jorie Barnett Johnson, a CFP licensee with Financial Futures LLC in Manasquan, N.J. She says that's partly because of the lack of knowledge about the plans--and sometimes unrealistic expectations--on the part of clients.
"One of my most financially savvy clients, a couple, are hesitant about putting money into a 529 plan because they think their child is very intelligent and will get a scholarship," Johnson says. "I told them that if their child gets a scholarship they can take out the money from the 529 without penalty. They didn't know that."
College, Or An Island?
Based on average costs for tuition, room and board and fees for 2007-2008, the total four-year tab at a private institution is an estimated $120,000 and for an in-state public four-year institution it's roughly $70,000, according to the College Board, a nonprofit group of schools, colleges and universities. With the assumption of realistic 6% annual increases in college expenses, a child born today faces projected four-year costs of $440,000 at a private college and $216,000 at an in-state public school.
That kind of money can buy a private island. And it isn't going to come from a plain-vanilla savings account at the local bank. That's where 529s come in.
Created in 1996 under Section 529 of the Internal Revenue Code, 529s are state-sponsored college savings programs where investment returns grow tax-free and withdrawals are exempt from federal taxes as long as the money goes toward qualified educational expenses including tuition, room and board, books, required equipment and fees. A large number of states also offer either tax credits or deductions for residents who invest in their state's 529 plans.
There are roughly 95 plans available in 49 states, along with about 20 prepaid plans that are guaranteed to increase in value at the same rate as college tuition (the downside is they offer a limited number of available college choices).
The maximum yearly contribution for individual donors to 529 plans is $12,000 per beneficiary. People getting a late start on the program can make a special lump-sum contribution of up to $60,000-$120,000 if they are married and filing jointly-to a child's account. But annual contributions during the next four years following this lump-sum contribution will trigger gift-tax penalties.