More families embrace 529 Plans amid rising education costs

With federal student loan forgiveness in threat and the soaring expense of college becoming a major issue for students and their families, more Americans are prioritizing college savings.

According to Fidelity's College Savings Indicator, 74% of parents questioned in 2024 had begun saving for college, up from 58% in 2007, when the study was initially conducted. From April to May, Fidelity polled approximately 2,000 households with children in high school or younger.

The increasing focus on college savings comes as no surprise, given the staggering rise in college costs over the past few decades. According to data from the National Center for Education Statistics, the average cost of tuition, fees, room, and board at four-year institutions has more than doubled since the turn of the century, even after adjusting for inflation. This dramatic increase has left many families scrambling to find ways to finance their children's education without resorting to crippling debt.

"My husband and I just kept hearing from people with older kids about how expensive college is," explained Kathryn Bracho, 48, of Green Bay, Wisconsin.

Bracho and her husband, Michael, began contributing to college savings accounts in 2017 so that their sons, Declan, 15, and Taran, 12, would have options after high school, she explained.

"I don't know that we have as much as we had hoped, but just the fact that we've been steadily contributing gives me a certain degree of reassurance," she told me. "They'll have to take out some loans but it hopefully won't be that crushing burden."

To be sure, sky-high tuition and fears about increasing student debt balances have had a significant impact on college decisions for students and their parents.

This shift in mindset is not just affecting individual families, but also influencing broader educational trends. Many students are now considering alternative paths to higher education, such as community colleges, trade schools, or online degree programs. These options often come with a lower price tag and can provide valuable skills and credentials without the burden of excessive debt. Additionally, some universities are responding to the financial pressure by offering more generous financial aid packages or implementing tuition freezes to attract cost-conscious students.

"Families are beginning to row in the same direction and realize the value of higher education and what they want to get out of it," said Chris McGee, chair of the College Savings Foundation, a non-profit that advocates for 529 plans.

"Nobody wants to be part of the $1.7 trillion," McGee stated, referring to the total amount of outstanding student loan debt.

David Ochs, a physician in Richmond, Virginia, owed $315,000 in college loans when he completed his residency. "It's been miserable," the 39-year-old stated.

As the father of two kids, ages one and five, Ochs said he began saving for their college educations soon after they were born because he didn't want them to go through the same struggle. "All of a sudden your life is all about trying to get out of a strangling debt."

Still, contributing to their 529 plans has required sacrifices, such as foregoing extra payments on his student debts, he explained. "I think it's a gesture of love."

According to a new report by the College Savings Foundation, nearly half of the 94% of parents who fund their children's higher education use savings as their primary method of payment. In July, more than 1,000 parents of children aged 25 and under completed the annual State of Higher Education Savings survey. For the first time in the College Savings Foundation survey's history, more than half of all parents reported using a 529 college savings plan.

Total investments in 529 plans increased over 10% to $450.5 billion in June 2024, up from $412.5 billion the previous year, according to data from the College Savings Plans Network, a network of state-administered college savings programs.

Financial experts and plan investors believe that 529 plans are a wise investment for many. Nonetheless, data from prior years reveal that monthly contributions to a 529 college savings plan were frequently pushed aside in favor of paying more essential bills or everyday costs. Even today, parents hope to utilize savings to pay for 67% of their child's education, but just 30% are on track to meet that goal, according to Fidelity.

The gap between savings goals and reality highlights the need for a multi-faceted approach to college financing. While 529 plans remain a valuable tool, experts increasingly recommend that families explore a combination of strategies. These may include encouraging students to apply for scholarships and grants, considering work-study programs, and exploring part-time employment opportunities during college. Some families are also turning to creative solutions, such as crowdfunding campaigns or family contribution agreements, where extended family members pool resources to support a student's education.

"A college education is still valuable, but the lack of planning is a little concerning," said Tony Durkan, vice president and head of 529 client management at Fidelity Investments.

Benefits of a 529 College Savings Plan

Among other recent changes, McGee said that larger contribution limits and the ability to roll unused funds into a Roth individual retirement account free of income tax or tax penalties had helped boost interest. The constraints on 529 plans have also been relaxed to allow continuing education courses, apprenticeship programs, and even student loan payments.

"The legislative updates that have come through have certainly broken down barriers to entry to 529 plans," Durkan, who works with Fidelity, said. Let's take a deeper look at some of the changes:

As of 2024, thanks to Secure 2.0, families can transfer unused 529 plan funds to the account beneficiary's Roth IRA without incurring income taxes or penalties. Among other requirements, the 529 plan must have been active for at least 15 years.

That move comes after the Secure Act of 2019, which allowed 529 users to contribute some of their funds toward student loans: up to $10,000 per year for each plan beneficiary, plus another $10,000 for each of the recipient's siblings.

Previously, tax-advantaged withdrawals were restricted to eligible educational expenses including tuition, fees, books, and room & board. Chris Lynch, head of tuition financing at TIAA, told CNBC last year that 529 plans now provide far greater flexibility, even for individuals who never attend college.

In that instance, you can either transfer the funds to another beneficiary or withdraw them and pay taxes and penalties on the earnings. If your student receives a scholarship, you can usually withdraw up to the amount of the scholarship penalty-free.

Higher maximum donation limitations

This year, parents can gift up to $18,000 per child, or $36,000 if married and filing jointly, without affecting their lifetime gift tax exemption. That's an increase from $17,000 and $34,000 for married couples filing jointly in 2023.

High-net-worth Families looking to assist support a family member's higher education may want to consider "superfunding" 529 accounts, which allows them to put five years' worth of tax-free gifts into a 529 plan at once.

In this situation, you might contribute up to $90,000 this year, or $180,000 if married. However, if you give more money to the same recipient within five years, it will count against your lifetime gift tax exemption.

According to Fidelity, a greater lump-sum investment made upfront may generate more rewards than a similar contribution spread out over a few years because of the longer time horizon.

New Grandparent 'Loophole'

A new simplified Free Application for Federal Student Aid was released at the end of last year, with additional incentives for grandparents who own 529 plans for their grandchildren.

Under the previous FAFSA guidelines, assets held in grandparent-owned 529 college savings plans were not disclosed on the FAFSA form, but distributions from those accounts were regarded as untaxed student income, potentially reducing aid by up to half.

As part of the FAFSA simplification, students are no longer need to answer questions about contributions from grandparents, essentially enabling a for grandparents to invest for their grandchildren's college without jeopardizing their financial aid eligibility.

This change has sparked renewed interest in multigenerational college savings strategies. Financial advisors are now encouraging grandparents to play a more active role in their grandchildren's education funding. By leveraging this new rule, families can potentially maximize their financial aid eligibility while still benefiting from the tax advantages of 529 plans. However, experts caution that families should still consider the overall impact on their financial planning and consult with professionals to ensure they're making the most of this opportunity without compromising other financial goals.

Tax breaks or credits for contributions

Even before recent modifications, there were numerous benefits to a 529 plan. More than half of all U.S. states allow you to deduct or credit payments. Earnings grow tax-advantaged, and withdrawals are tax-free if utilized for eligible educational costs.

A few states also provide additional perks, such as scholarships or matching grants, to people who invest in their state's 529 plan.

As the landscape of college savings continues to evolve, it's clear that families are becoming more proactive and strategic in their approach to funding higher education. While the challenges of rising costs and potential debt remain significant, the expanding options and flexibility of savings vehicles like 529 plans offer a glimmer of hope. As more families prioritize college savings and policymakers continue to address the issue of educational affordability, the dream of accessible higher education may become more attainable for future generations of students.