After comparing and choosing a 529 plan, the next challenge is how much to contribute to the 529? While the IRS has not defined an exact limit for the amount that may be contributed to a 529 plan, some state plans have set a limit on the amount of contributions you can make; however, the limits are in the hundreds of thousands of dollars so what you want to be aware of is that your contributions may cause a gift tax. Each parent may contribute up to $13,000 per year for 2012 and $14,000 for 2013 without paying federal gift tax. Also, each parent may opt to accelerate up to five years’ worth of contributions—$65,000 for 2012 and $70,000 for 2013— into one contribution and still avoid federal gift tax, provided that no more contributions are made to the account for the next four years. If $13,000 or $14,000 a year is too rich for your budget, the good news is that you do not need to contribute thousands of dollars to start saving for college! You can usually open an account with less than $100.
The amount that you choose to invest in a 529 will be dependent on many factors, including the age of your child, the current cost of tuition, the expected rate of inflation on tuition, the return you expect to earn on your investment, and how much of your child’s education you wish to fund.
Here are some examples:
- If your child is 1 year old and you would like him or her to go to UC Berkeley, the total cost for tuition and housing for 4 years (assuming 6% inflation) is currently $319,234. Hard to imagine, I know. However, to achieve that sum of money, it only requires saving a little over $700 per month (assuming an 8% return on your investments). Since the child is very young you have more time on your side for that money to grow.
- Taking the same example from above, but assuming the child is 5, you would need to save close to $835 per month.
- If the child is 12, the amount jumps to almost $1,300 per month!
As you can see, time is a big factor in how much to contribute.
Another large factor is the cost of the college. In the above example we used UC Berkeley. However, if you would like your child to go to California State University, Sacramento and your child is 1, the total cost of tuition and housing for 4 years (assuming 6% inflation) is currently $175,225, which is close to half of the cost of UC Berkeley. This breaks down to needing to save about $400 per month (assuming an 8% return). If the child is 5, the amount goes up to $450 per month and, if he or she is 12, the amount is just over $700 a month.
Another thing to be aware of is the assumptions we are using: the 6% inflation factor for the cost of college; the 8% after-tax return of your 529 investments; and that your child will finish school in four years. Changing any one of these assumptions will affect the total cost.
These examples are guidelines illustrating the impact of time and inflation on the cost of college. What is important is that you start saving what you can as early as you can. As stated earlier, most 529 plans have a minimum investment of $50-$250, with additional minimum contributions from $15-$50.
Don’t think you have to be the only one funding the 529. Remember from our first blog we said that contributions can come from anyone—you, the grandparents or other relatives, or friends. You can help grow your child’s 529 plan by requesting that relatives and friends make contributions as gifts instead of presents of toys or clothes.
Our previous blogs focused on your options for savings for college and what to look for in a 529 plan. In this blog we discussed how much you need to put into the 529. Our next blog will address saving for your child’s college vs. saving for your own retirement.