By: Shaw Pritchett
A friend recently asked me for some advice regarding an account she had set up for her child’s college fund. It provided me a great opportunity to get some thoughts together to share regarding best practices for education planning.
1. First-start saving now. As with most financial plans, discipline in saving and spending is the most important factor in a successful outcome. I think it is even more so in education savings. You may have 40 years to save for a retirement that may last 30 years; with education savings, you probably have 18 years to save for four to eight years of spending. Your timeframes for both saving and spending are compressed and, because of that, the benefit you get from compounding will be less. You can always start small and ramp it up later, but whatever your goal, save early and save often.
2. Plan contributions are subject to gift tax rules. This means that for 2024, contributions to beneficiary’s account are limited to $18,000 per donor ($36,000 total from two parents). You can increase funding by leveraging other family members such as grandparents to add additional contributions. Additionally, you can elect to pre-fund up to $180,000 to a beneficiary this year by making a tax election that will spread the contribution against the annual gift exclusion over five consecutive years.
3. Consider a 529 plan to hold education savings funds. The most important thing is that you start saving in any form, but if you want to be efficient with your savings, consider using your state’s 529 plan. Since I’m from Alabama, I usually recommend the Alabama College Counts Plan because contributions up to $10,000 qualify for a tax deduction on your Alabama tax return. Additionally, all state plans allow your money to grow in a tax deferred manner and if you use the money for qualified college expenses, the investment gains you earn pretax-free.
4. Don’t try to get too exotic with your investment approach. No matter the state, most plans I’ve seen use a highly diversified, passive investment approach using low-cost mutual funds and ETFs. You may be tempted to pick your own investments within the plan options, but I would recommend you use the plan’s model portfolios. These models are usually age-based, starting more aggressively for younger beneficiaries and cycling to almost no equity risk for college-aged children. You don’t want your child’s college savings jeopardized by a market correction just when it is time to use the money.
5. Watch out for plan expenses. Though most states use similar investment options with familiar names such Vanguard and BlackRock, keep in mind that plan administrative expenses can vary by state, so be sure to evaluate those expenses against any tax deductions or credits. Hopefully, this helps to get you started on the right track towards education saving.
Shaw Pritchett is a Financial Advisor and President of Jackson Thornton Asset Management in Montgomery.
