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You’ve probably heard that on Tuesday, President Obama dropped a proposal to end 529 college savings plans.
The proposal, which the president pitched during his January 20th State of the Union address, was opposed by members of both political parties. “Given it has become such a distraction, we’re not going to ask Congress to pass the 529 provision so that they can instead focus on delivering a larger package of education tax relief that has bipartisan support, as well as the president’s broader package of tax relief for child care and working families,” a White House official said, according to the New York Times.
Also known as College Bound Funds, 529s are accounts in which parents can invest after-tax dollars that grow tax-free over the lifetime of the portfolio, and even when parents withdraw the money to use on college or other approved higher-education expenses, they don’t have to pay taxes on the earnings. “A 529 is currently the most tax advantageous for saving,” Mark Kantrowitz, senior vice president and publisher of Edvisors.com, tells Yahoo Parenting. “Still, most people don’t even save a year’s worth of college cost in a 529. The average saved in a college savings plan is a little bit less than one year of tuition.”
Kantrowitz says parents who can afford it should start contributing to a 529 as soon as their child is born. To figure out just how much parents should be saving, he says they should first take into consideration what he calls the ‘three-times rule.’ “College cost goes up by a factor of three over the course of 17 years,” he explains. “So from birth to college age, college tuition triples.”
Next, think about his one-third rule. “For any expense you don’t pay out of pocket — like college, unless you’re Bill Gates — one-third will come from past income, which is savings, one-third will come out of present income, and one-third will come out of future income, in the form of loans.”
Given those numbers, if you have a baby this year, your goal should be to save as much as four years of college would cost in 2015, by the time newborn is ready to head off to freshman year.
“Different colleges have different costs, and you can’t predict what specific college your kid will attend the day he is born, but you can probably predict the type of college – in-state public, out-of-state public, or private,” Kantrowitz says. Given that, Kantrowitz says parents’ monthly contribution from birth to a 529 plan should be $250 for an in-state public school, $400 for an out-of-state public school, and $500 per month for a private, non-profit school. If parents contribute along those guidelines, he says, that money, plus the interest earned over the course of 17 years, should amount to one-third of tuition when a child is ready to go to college. “Time is your greatest asset,” he says. “If you start at birth, one-third of your college savings will come from earnings.”
Adding that money — $250, $400 or $500 — to a family’s expenses can seem daunting, but Kantrowitz says there are ways to make it more manageable. “Make it automatic,” he says. “Once the money is no longer in your account, you quickly adjust.” He also suggests reevaluating your contribution when other large expenses—like day care or diapers—are no longer necessary. “Since you weren’t living on that money, it feels easier to redirect.” Finally, should you receive a tax refund or other windfall, put at least half into college savings, he suggests.
If nothing else, Kantrowitz says parents should live by one simple rule: “Save early and often.”