There’s a smart way to save for college, and it looks like American families are finally catching on

It's a flexible — and tax-free — college savings plan.

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It’s a flexible — and tax-free — college savings plan.
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University for the Creative Arts/Flickr

  • Nearly 30% of American families are now saving for college using 529 saving plans, according to a Sallie Mae report.
  • The money in a 529 grows completely tax-free and can be withdrawn tax-free at any point, so long as it’s used to cover college tuition, fees, books, and supplies.
  • The average savings amount in 529s nearly doubled from $2,820 in 2016 to $5,441 in 2018.

College is a costly endeavor, that’s no secret.

But paying for it doesn’t have to be a huge financial burden, so long as you’re saving the right way.

According to Sallie Mae’s 2018 “How America Saves for College” report, parents report saving the highest amount for college since 2013 at an average of $18,135. What’s more, one of the smartest ways to save for college is finally being utilized by more American families: the 529 college savings plan.

It’s a state-sponsored, tax-advantaged investment account that’s been around since 1996. While a general savings account is still the most commonly used by parents for college savings – 45% compared to 29% of families who save in 529s – a full 30% of college savings dollars are now held in 529s, compared to 22% of total dollars saved in traditional savings accounts, according to the report.

The average savings amount in 529s nearly doubled from $2,820 in 2016 to $5,441 in 2018.

529 plans are tax-free and flexible, and contribution limits are high

What many people may not realize is 529 plans are incredibly flexible. A parent, grandparent, godparent, or anyone else can open an account and start contributing – whether through direct contributions, payroll deductions, or automatic transfers – before a child is even born. The money grows completely tax-free and can be withdrawn tax-free at any point, so long as it’s used to cover college tuition, fees, books, and supplies.

The average cost per year to attend an in-state public school today – including tuition, room and board, and fees – is $20,770, according to the College Board. If you start saving in a 529 as soon as your child is born, and continue saving all the way through graduation day, you’ll have to contribute $338 a month to pay in full, according to savingforcollege.com’s college savings calculator.

Read more: College is more expensive than it’s ever been, and the 5 reasons why suggest it’s only going to get worse

This assumes that a family begins with $0 in college savings, plans to cover 100% of the costs for full-time attendance at a four-year college, and that costs increase of about 3% each year, which is close to its 10-year historical rate of increase. It also doesn’t factor in supplemental tuition help, like grants or scholarships.

To afford a private college, where the annual tuition is about $46,950 today, you’ll have to contribute $765 a month for 18 years to cover a child’s college costs.

Luckily, contribution limits for most 529 plans are high, starting at $235,000 in some states. Contributions are considered gifts, however, so savers looking to avoid paying gift tax in 2018 are limited to the annual maximum gift of $15,000 for each child (married couples can give $30,000 for each child). That said, you can also can front load an account with up to five years’ worth of contributions, or $75,000 and $150,000 respectively.

Since the plans are state-sponsored, each state runs one or more of their own, and savers are allowed to choose which they prefer. At savingforcollege.com, there are 110 options, and each one has a slightly different investment structure – the site lets you compare investment options, fees, and various tax benefits of each plan. Currently, more than 30 states offer tax deduction or credit for 529 plan contributions as well.

While the adult who opens the plan is the owner, the beneficiary is the individual who receives the money – and it can be changed.

If one child decides not to go to college, goes to a cheaper school than expected, gets a full scholarship, or for some other reason doesn’t use all of the money, you can simply change the beneficiary on the account and give those funds to another child … or even to the parent, if they chose to go back to school.

Under the 2017 Tax Cuts and Jobs Act, you can now also use a 529 plan to pay for up to $10,000 in private or public elementary, middle, and high school tuition.

Keep in mind that you’ll need to chose how the money saved in a 529 plan will be invested. The best option for the average person is typically an age-based portfolio, which will reduce risk as the child approaches college.

Additional reporting by Libby Kane.