Don't Use a 529 Savings Plan? Maybe You Should
By Allison Bisbey Colter
The typical American family is on track to cover 24% of the cost of its children's college education, based on their current and expected savings, according to a survey by Fidelity Investments.
For the purposes of the survey, the typical American family has one or more children 18 years or younger who are expected to go to college, and a household income of at least $30,000. Research Data Technology, the independent firm that conducted the survey, interviewed nearly 2300 parents.
The survey found that respondents saving through 529 college savings plans are in a significantly better position; they are currently on track to finance 52% of expenses.
These plans, named after a section of the Internal Revenue Code, are operated by states and educational institutions. Investments held in 529 plans grow tax-free, and distributions used to pay for the beneficiaries' college costs are free of federal taxes, though withdrawals used for other purposes may be subject to income tax and penalty taxes.
Nevertheless, only 26% of respondents reported having any savings in a 529 Plan or other dedicated college account.
Instead, 42% favor saving in general accounts; preferring the flexibility of being able to tap the money should they need it for other purposes.
Ignorance may help explain why a relatively low number of respondents use them. More than 21% of parents who are not currently saving in 529 Plans say they are not aware of these accounts, while 19% believe they can get better returns elsewhere, according to the survey.
Fidelity, one of the biggest managers of these tax-advantage plans, says it's unclear whether respondents are taking into account the tax-free status of these vehicles.
Still, 529 plans aren't free of costs. Management fees, which eat into returns, can vary widely from plan to plan and among investment options within plans. Plans sold through investment advisers are also typically subject to an up-front sales commission.
Fidelity says the percentage of college costs parents are on track to cover through savings decreases as children approach the age of college matriculation. Fidelity believes this is likely due to parents saving less over time than they had projected.
Parents expect children to pay 18% of college costs through student loans, a potentially sizeable burden. For example, using the College Board's estimated total costs for an average four-year college beginning in 2008 to 2009 school year, student loans would have to cover $18,000. The total costs of those loans, assuming they are paid over 10 years at an interest rate of 7.5%, could exceed $25,000, according to Fidelity.
But it might not be every parent's goal to cover all of their children's college costs. Indeed, 79% of those surveyed believe their children will appreciate college more if they share the responsibility of paying for the education.
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