How Much Do You Need to Fund a 529 Plan?

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An excellent way for a family to save for college, while sheltering income, is a 529 plan and their counterpart, education savings accounts (ESAs or Coverdell accounts). The IRS allows a family to fund a tax-deferred account for a child, which can invest in stock or bond mutual funds and money market funds. 529 plans and ESAs provide a family with an obvious income tax advantage, and a sound strategy for financing college tuitions, which are high, and rising at over 6% annually. Putting income into a college savings account is a no-brainer.

Like anything though, the execution requires planning and financial expertise.

Is there a clinker to all of this? Well, yes. The six-figure question is, “How much will I need to accumulate in a 529 plan?” Coming up with a “529 number” is tougher than it sounds. Should we put in $25,000 or $125,000? A large advisory firm was telling clients to budget for $150,000 per child. I asked them how they arrived at such a nice, round figure. “We’re not sure, but it sounded good.”

Because of the wide array of costs, families don’t know how much or even what to budget. And those costs can vary by factors of five or more. Tuition alone can range from $5,000 to $75,000 annually for undergrad programs. Families assume their child will graduate in four years, yet the nationwide average is 5.3 years. Tuition accounts for only about half of the total cost of college for families who send their child to a state school. According to Sallie Mae, families’ commonly under-estimate the total cost of a four-year college education by 50%.

Creating a financial plan for college is crucial, and that financial plan determines a family’s 529 number.

529 plans and ESAs

There are two choices for tax-advantaged college savings plans: 529 plans and ESAs. Both offer tax-deferred growth, provided the proceeds are used to finance qualified education expenses (tuition, books, computers, and room and board). Though the principal and any gains can be withdrawn tax free from both 529 plans and ESAs, there are important distinctions regarding eligibility and contribution amounts provided by these plans.