Hi. I’m Stuart Ritter, a senior financial planner with T. Rowe Price.
I also taught personal finance at Johns Hopkins University for several years, and am a member of the Maryland State Department of Education’s Financial Literacy Education Advisory Council.
I also teach Howard County General Hospital’s Maybe Baby? Financial Planning for Prospective Parents course and, most importantly, my wife and I have three young kids.
In this video, I’d like to talk to you about saving for college.
Let’s get into this by looking at the problem we’re trying to solve.
Let’s say your child ultimately goes to go to State U, and it will cost $100,000when they do. (I know – big number!)
That means you’ll need to give State U $100,000 for your child to enroll – that’s no different than wanting to buy a car or purchase a pineapple.
To drive it off the lot or carry it out of the store, you need to pay $100,000. If you don't have $100,000, you don’t get to buy it.
So where will we get that amount?
Hopefully, from savings.
The more you have in savings, the more options, flexibility, and control you have over which schools your child can attend, when they can go, how much they might need to work when they get there, how often you can afford to visit, etc.
And saving over time reduces the impact of trying to come up with such a large amount of money all at once, allowing you to budget while maintaining your current lifestyle.
But if we don't have enough in savings, we have to hope that either someone else comes up with some money – or we have to borrow it.
Let’s stick with that saving idea first. And one of the best places to save is in something called a 529 plan.
First, let me explain why it’s called a “529 plan.”
It’s because its features are described in Section 529 of the Internal Revenue Code. Incidentally, that’s how 401(k)s got their name . . . and 403(b)s . . . and 457s . . . but I digress.
Although not too far. The benefit of a 529 plan has to do with taxes.
Saving in a 529 allows you to pay less in taxes – which means you have more money to spend on college!
Let’s get into this by reviewing how taxes on gains normally work.
Let’s say you set aside some money for college. Later, when it’s time to pay the bill, you sell whatever’s in the account so you can write a check.
If you’ve put the money in a regular, taxable account, you have to take part of whatever gain you might have earned and send it to the government as taxes.
You get to spend whatever’s left.
If you’d used a 529 plan, on the other hand, any increase in value is not taxed, so you have the entire amount in the account to spend.
In addition, some states will give you a benefit on what you put in, as well as the benefit you get when you take money out.
And that’s what makes a 529 plan so powerful – it can give you more money to spend than you’d otherwise have.
There are two kinds of 529 plans – and both give you those tax features.
There are college savings plans where you contribute money, invest it in the funds available in the plan, and can spend whatever the balance ends up being.
The second kind are called prepaid plans where you’re essentially buying years of college.
Regardless of which kind you use, you can spend your 529 money on tuition and fees at any accredited college in the U.S. – and even some outside of the U.S.
And the college savings kind lets you include room, board, books, and some costs as “qualified educational expenses.”
When you open an account, you chose a beneficiary for the money. You can change that beneficiary at any time – to a relative as distant as a first cousin.
And you’re in control of the account the entire time. You decide when money comes out, how much, and how it’s spent.
You can find more details in the documents describing whatever plan you’re interested in.
The IRS is playing “Let’s Make A Deal!” You put your money in a 529 plan and they give you tax benefits.
If you don’t hold up your end of the bargain – if you spend the money on something other than qualified educational expenses – two things happen:
1. They take taxes from the gain, just as they would have if you’d used a regular account.
2. And, second, there’s a 10% penalty for breaking the agreement.
The 10% penalty is waived in certain circumstances, so be sure to read the information about the 529 plan to know the details.
One question I often get is, “How will a 529 affect financial aid?”
First, a 529 plan doesn’t affect your financial aid any differently than if you’d held that money in a regular taxable account, so there’s no special ‘problem’ with 529 plans when it comes to the financial aid calculation.
Now, let’s go back to where we started – needing to pay $100,000 for State U.
As I mentioned, the money to do so will come from Savings and Financial Aid.
In the Federal Financial Aid formula, there’s actually a formal term for what the school expects your family contribution to be.
It’s cleverly named, “Expected Family Contribution or (EFC).”
Any financial aid you might receive starts after the amount you need to kick in. Here’s what that looks like:
So let me pose a question: Where are you going to get the EFC amount you’d need to come up with before financial aid even kicks in?
Let’s say your EFC is $15,000 . . . per year . . . for four years.
If you haven’t saved in advance, where will you get $60,000? You’ll need that $60,000 regardless of what happens with financial aid!
Second, any money you’ve saved only reduces your financial aid about 5.6 cents for every dollar. That’s right – about a nickel! So worry less about lower financial aid, and worry more about needing that 60 grand!
How do you get started with a 529 plan?
First, your state probably offers one – so start by looking at that.
Second, state treasurers from around the country have put together a website about 529 plans at
Lastly, Morningstar, a leading provider of independent investment research, provides ratings on 529 plans at
Opening an account is as simple as filling out some information on a website or form.
Before we wrap up, I want to go back to that financial aid topic for just a moment.
Too often, we’re misunderstanding the term “financial aid.”
When we say it, we think it means “free money” and, therefore, we wouldn’t want to do anything that would reduce how much we get.
Except . . . financial aid, in almost all cases, is not “free money.”
It’s loans – and potentially lots of it.
You’ve heard the statistics: According to the average student graduates with around $20,000 in loans; some end up with much more than that – and so do their parents!
So here’s a little unconventional mental exercise I’d encourage you to go through.
Any time you think or say something that uses the phrase “financial aid” – think or say it again, but substitute the phrase “massive debt” where you had “financial aid.”
For example, if you’re thinking, “I’m not sure I want to save in a 529 plan because my child might not get as much financial aid.”
Restate it as, “I’m not sure I want to save in a 529 plan because my child might not get as much massive debt.”
Or, “I’m going to read up on the steps I can take to get the maximum financial aid.”
That turns into, “I’m going to read up on the steps I can take to get the maximum massive debt.”
Looking at it that way, you might just change your mind about saving for college.