The True Impact of 529 Plans on Attendance, Affordability, and Financial Aid

True Impact of 529 Plans on CollegeI’m at the stage in life where I get a lot of positive pressure to put money aside in a 529 college savings account for our children.

If you have children, I’m sure you get the same pressure.

If you’re like me though, you took action and you opened up a 529 plan and have started making automatic contributions.

But you might have that nagging question in the back of your mind,

“when my child heads off to college in x number of years, will this really have a positive impact on the affordability? (i.e. will this really work out to benefit my child?)”

Let’s take a look at the impact the 529 plan is having and how you can calm that nagging questions above.

How 529 Plans Are Being Used

On a macro level, we know that 529 plans are gaining popularity. However, their impact on the U.S. college student is still very small. They currently aren’t being used by many folks. Only around 5% (or 1.4 million) of U.S. college students actually used a 529 plan in 2011 to pay for some of their college education.

So even though you and I know and use 529 plans, parents of kids heading off to college today didn’t know much about them or didn’t bother to learn about them and use them.

It does get better when you look at the average balance. In 2012 that number was around $17,000. While that won’t pay for an entire four years at most colleges, it’s evidence that people who have 529 plans are doing some serious saving.

How You Can Improve Your Chances of 529 Plan Success

Let’s go back to our question: will the 529 plan really work out to benefit my child? The three factors involved in answering the question for yourself are:

  1. What will the cost of college be like when my child graduates high school?
  2. Is my savings enough, or will the return on my savings be enough?
  3. Will my 529 plan assets reduce the financial aid my child receives?

We can somewhat control the first two factors. And the third likely isn’t much to worry about.

Controlling Costs of College

While we can’t control the actual cost of an individual college, by being open to choosing a more affordable college, we can remain flexible in our choice and choose the college that makes the most financial sense when our children graduate.

By 2030 it will likely cost a quarter of a million dollars to attend a private university (crazy), but a public university will probably cost $100,000. Still insane, but it shows the huge difference choice can make. And if your child is willing to do 2 years at a community college, then that price could be reduced even further.

Controlling Savings and Return on 529 Plans

We can certainly control how much we save each month towards our 529 plan. Even if it’s just a small amount each month, it can have a pretty big impact. $50 a month over 18 years at 7% expected return will net $21,700. Invest a couple of tax returns over the years and that number could be much higher.

We can’t control the stock market return, but we can diversify our investments within our 529 plans such that they aren’t exposed to a great deal of risk the closer your child gets to graduation.

So the bottom line seems to be to save more, diversify, be flexible in college choice, and temper your expectations about covering 100% (which may not be desirable anyway…see my thoughts on millionaires below).

Controlling Financial Aid Impact of 529 Plans

But what about that third factor? How will your federal education assistance be affected by what you have saved in your 529 plan? If you look at the FAFSA right now, the 529 plan is supposed to be considered as an investment asset owned by the parents. This will have an impact on how much federal student aid the student will qualify for. But only by a small amount.

According to Vanguard, the worry about 529 plan impact in financial aid is unfounded. Parents get to exclude some non-retirement assets (including the 529 plan) and those 529 plan assets that do get included are only able to affect financial aid by a maximum of 5.64%.

So if you have $25,000 saved up in a 529 plan and you can’t use the non-retirement funds exclusion (because you have a boat load of cash, for instance), your child will receive $1,410 less in financial aid. While that’s not chump change, it isn’t a reason to stop using your 529 plan.

Additionally, some private colleges take into account the 529 plan assets when doling out aid packages. From all of the poking around that I’ve done it appears that this is a college by college impact and so your best bet is to be in contact with the college to learn of their policies. All the more reason to stay flexible with college choice.

How One Family Used Their 529 Plans

When it comes to diversifying contribution sources, some people use a hybrid approach involving a 529 prepaid plan and a savings plan to guarantee that most or all college expenses will be affordable. Here’s an example:

Here’s Jan Keenan, a mom of three recent college graduates and an attorney at Keenan & Austin, P.C.. She chose to use a hybrid approach to create a little more security with her education savings.

We bought MET (Michigan Education Trust) contracts for our three children when they were 12, 11, and 8. We also put money into 529 savings plans for them when they were a few years older. The MET contracts paid for their tuition, and the 529 savings plans paid for their room, board and books.

We paid $20,000.00 for each MET contract and they paid out an average of about $40,000.00 in tuition costs for each child. We put $22,000.00 into the 529 for our oldest, $21,000.00 for our middle child, and $18,000.00 for our youngest. By the time each kid got to college, they each had about $28,000.00 in their 529 accounts.

Remember that prepaid plans have their pros and cons, so make sure you understand the difference between a 529 savings plan and a 529 prepaid plan at the individual state level. But I do like this hybrid approach and honestly I’d never thought of it. Prepaid plans are only available in some states.

The Millionaire Next Door Shouldn’t Pay for Their Kid’s College

I’ve been listening to the Millionaire Next Door lately and the authors spend a lot of time talking about how millionaires (specifically the next door variety) end up using their wealth for their kid’s education (private schools, colleges). They say that this is a mistake because children that receive large financial gifts are not frugal with that money.

The need for frugality is what is credited with making the millionaires next door millionaires to begin with. So by giving your children a big financial gift you are depriving them of one of the factors that will help them become a millionaire themselves.

I’m a believer in that approach. Mrs. PT is a staunch believer in it. The money we have saved in our 529 plans for our children will be more of a supplement. Right now we are placing $25 a month for each child into 529 College Savings Plans with Ohio’s College Advantage plan.

With a few lump sum contributions and some birthday money, we will likely be able to help our girls out with a few semesters of college. We’re excited to see our kids taking some responsibility for the cost of their education. They can do this by working, using scholarships, or even taking small loans (which I’m not entirely opposed to).

What about you? How are you using, or how did you use, a 529 plan to save for college expenses? Are you worried that the money will be there when you need it? Are you worried about the cost of college?

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  1. Great observations, Phil. I have a 529 plan for my daughter, but it’s not heavily funded. I think we have a couple thousand in it right now, but we’re only putting $25 a month into it. (We started with a lump sum just to get it seeded). I also fit into the same mold as you and your wife – I want to help my children, but I don’t want to do everything for them. I want them to be able to earn scholarships, or somehow pay for a portion of their education. I think it will help them in many ways.

  2. Good post. For the cost conscience one thing to consider is for some programs much of the costs are fixed administration costs per fund and can be steep. I had selected three different style funds for each child (thinking diversification) until I realized the cost hit and reduced selections to one diversified fund.  As I understand it, the name on the account does not mean the monies need to be used for that child – so it seems a way to reduce costs further for multiple youngsters is put them in one name, say the oldest child, and have them all eventually draw from it when needed. Are there any problems/issues with this approach?

    • Philip Taylor says:

      @Dan Good point about cost. I chose an age-based option (somewhat like a target-date fund) and made sure to look at the expense ratios. You are right in that beneficiary can be changed, but there are some drawbacks to this approach: 1. if you die, there is confusion about who gets what money, 2. it’s harder to manage risk, especially if kids are 5+ years apart (you’ll want to be heavy into cash and bonds when your oldest is 17, but you wouldn’t want those same funds for your 12 year old).

  3. CommonCentsWealth says:

    This is an excellent post.  I’ve heard a lot about possibly getting less financial aid because of the 529 plans, but it’s nice to know that the effect isn’t that much.  I completely agree with you and your wife’s opinion that kids should have to pay for a portion of their own college.  My wife and I are planning to do the same thing.

  4. Why Ohio and not texas, your home state?

    • Philip Taylor says:

      @Will Great question. There is no state tax in Texas, so we don’t have a tax incentive via a deduction to do a plan here. The best plans (in terms of costs and investment options) were in other states. At the time I started (back in 2009), the Ohio plan was one of the top rated. All “savings” plans let you take your money and use anywhere. It’s the prepaid plans that sometimes have restrictions on use. Here in Texas the prepaid plans have restrictions. Since I’m not choosing where my girls go to school, I don’t want to handicap them by creating a financial penalty for going out of state.

  5. rwohlner says:

    Good post Phil.  I’m personally a fan of 529 plans, but not the prepaid tuition plans.  Part of this comes from living in IL where most things the state touches turn to ___.   A couple of years ago there was some talk of the state not being able to meet its obligations in terms of covering the tuition units paid for, something similar happened in Alabama as well.  As far as paying for the kid’s education, we have funded a substantial part and this has varied by child.  Our daughters both earned substantial scholarship and grant money to pricey private schools.  Our son is at a state school and we have footed that bill.  Our middle one is off to law school next fall and we’ve told her it is on “her dime.”  Thankfully she did receive a scholarship that amounts to 1/2 of the tuition and fees.  Our feeling was that we wanted to make sure all three kids got through undergrad with little or no debt and we were mostly successful.  As for private schools being $250,000 by 2030, I’d say how about 2013?  The full cost of Northwestern where my daughter just finished a quarter early is just over $60,000 annually according to the estimate provided by the school.  This is “all-in” including housing, food, etc.

    • Philip Taylor says:

      rwohlner Great comment, rwohlner . Texas had a funding issue with their prepaid plan as well. I think that’s what scared me away when I was first looking into saving. Thanks for sharing your experience. I should have reached out to you for your story for the article. Sounds like you guys have a good handle on things. Yeah, the $250,000 is just tuition alone and average. Sounds like Northwestern must be above the average. Here’s the background on that number in case you are curious:

      • Philip Taylor rwohlner Not to be Debbie Downer, I generally use a 7.5% annual increase in my financial planning assumptions for college costs.  Pretty depressing for a parent with young children.  As I alluded to above, for kids who are top students with high test scores private schools can ultimately be a better value than a state school as they can often put together a much better financial aid package (including merit aid) to get the students they want.

  6. The Military Guide says:

    Good post, PT.  I wish 529s had been around when our daughter was born in 1992, but the plans didn’t start until 1996 and had fairly high fees for those days.  Every time I came back for another look our UTMA, I bonds, and CDs were still performing better than a 529.
    Even if a family had jumped right on a 529 plan when the legislation was created, their child would just now be turning 17 years old.  I suspect we’ll see a dramatic rise in their use over the next five years.

    • Philip Taylor says:

      The Military Guide Good points, Doug. There are currently somewhere north of 10 million 529 plans being held today. Hard to say how many of those are within a year of graduating, but I do think that 5% will become 10% fairly quickly.