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The most important thing you can do to get ready for college costs is to save — early and often.
But saving for college can be bit of a maze. Like retirement, there are several different types of plans, like a pre-paid plan which lets you buy a percentage of tuition in advance, or a 529 plan, which lets you invest money and let it grow without a big tax bill when you start using the money.
Kimberly Lankford, contributor to Kiplinger Personal Finance, says 529 savings plans are one of the best ways to save for college. “The money you put in may be tax-deductible, the key thing is the money grows tax-deferred for years and years, and when you finally use it for college expenses, it’s tax-free.”
And how much should you start with? “Nothing is too early. As soon as you have a baby born, even if you got just a little bit, [saving] that would be great. A lot of these plans let you invest just $25 or $50,” Lankford says. She also notes that many plans can automatically take investments from your savings account. This type of ‘set-it-and-forget-it’ approach is an easy way to start saving.
Lankford notes that you should check to see if your own state offers a tax deduction for investing in its 529 plan. SavingForCollege.com can be a good resource to compare the 529 plans available.
Not all 529 plans are great. Since the money is invested in mutual funds, it’s important to look out for fees and the holdings of each fund. “Especially after 2008 [and the financial crisis], there’s been criticism of some of these age-weighted funds where they start out of more aggressively and gradually get more conservative,” Lankford says. “Some of these didn’t get conservative fast enough.”
One alternative to a 529 plan is a pre-paid tuition plan. “With a 529 plan, your money is invested in mutual fund and grows through the years. A prepaid plan on the other side has you using today’s dollars to buy [a future share of] tuition. You can set aside a certain amount of money now, and that will guarantee you get a certain share of tuition down the road.”
But prepaid plans also have drawbacks. Unlike a 529 savings plan, you’re usually locked into only using your savings in the same state you invested in. A 529 plan lets you use that money for any college.
Lankford says, “the key thing is for the person with a newborn or a child in elementary school, they still have many years until the child starts college. Don’t get freaked out about the short term blips.”
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