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Contributions to college savings plans are increasing as inflation moderates

by SuperiorInvest

Contributions to 529 college savings programs fell late last year and early this year, according to industry data, as consumers saved less overall and struggled with high inflation. However, posts seem to be picking up again in recent months.

State-backed savings accounts, named after a section of the tax code, can be used to pay for educational expenses, especially college costs. Money deposited in the accounts grows tax-free and is withdrawn tax-free when spent on eligible expenses such as tuition, room and board, and books.

In the first three months of the year, estimated net inflows to 529 savings plans — contributions minus withdrawals — totaled $1.6 billion, down from more than $3 billion a year earlier, according to ISS Market Intelligence, a financial research and analysis firm. Still, that was an improvement from the fourth quarter of 2022, when net inflows were $1.5 billion. And those fourth-quarter inflows were well below the more than $4 billion in the same period in 2021.

The drop in contributions was the result not only of lower overall savings and high inflation, but also of the post-pandemic reopening of the economy, which has released pent-up demand for spending, Paul Curley, director of savings research at ISS, said in an email.

It didn’t help that last year was a dismal year for investors, including those with money in 529 plans. Losses in 529 plans particularly hit families with children who were already in college or just starting college and had little time for their assets to recover.

“People may contribute less when they feel less wealthy,” said Pam Lucina, senior director of fiduciary services at Northern Trust, a financial services company.

Stock market gains this year, along with slowing inflation, have encouraged families to put more money into 529s, Mr. Curley said.

Rachel Biar, president of the College Savings Plans Network, a group of state 529 plan administrators, said last year “was a challenging year.” But she added, “We’re seeing contributions coming back.”

For example, contributions to the Nebraska 529 plan, which Ms. Biar oversees as assistant state treasurer, rebounded to nearly the same level as a year ago, she said.

Despite market volatility, Joel Dickson, global head of advisory methodology at Vanguard, said the fundamental value of 529s as a tax-advantaged way to save for education hasn’t changed.

“It still makes a lot of sense,” he said.

An annual survey at Edward Jones shows that while respondents want to save for college, two out of three don’t know what a 529 plan is, said Steve Rueschhoff, director of managed investments at the company.

Overall, the 529 plan assets, reflecting deposits and investment gains, totaled nearly $409 billion in the first quarter of this year — down from $432 billion a year earlier, but up more than 5 percent from $388 billion at the end of 2022.

Despite recent market swings, 529 plans offer a way for families to reduce the amount they have to borrow for college, Ms. Biar said. The College Board estimates that average annual cost in the state attending a four-year public college is $27,940, while the cost of a four-year private nonprofit college is $57,570.

“We still want people to consider a 529,” Ms. Biar said, adding that most plans have conservative options, including savings accounts that are federally insured, for people who can’t tolerate the risk.

The College Savings Plans Network works to increase awareness of college savings plans and supports legislation that expands permitted uses for 529 funds. For example, Congress expanded the allowable use of 529 funds to allow families to save for educational expenses other than college costs, such as K-12 tuition as well as apprenticeships. Plus, up to $10,000 from a 529 can now be used to pay off student loans.

Starting next year, under the Secure 2.0 Act passed in 2022, “leftover” funds in a 529 plan can be rolled over into a Roth individual retirement account for the 529 beneficiary. That’s helpful, Ms. Lucina said, because some families may be reluctant to contribute to a 529 for fear that they’ll owe taxes and penalties if they don’t spend all the funds in the account — say, because their child doesn’t spend to go to college — and they choose to use the money for other purposes.

“People are worried about overfunding 529s,” she said.

Under the new law, up to $35,000 can be transferred from a 529 to a Roth IRA. Each year, you can roll over up to the maximum annual Roth contribution — currently $6,500 for those under 50. If you have more left over, you would have to transfer it over the years.

Other rules apply: For example, a 529 account must be open for at least 15 years, and no contributions or earnings from the last five years can be rolled over.

Still, if you don’t qualify for a Roth rollover, you can avoid paying taxes and penalties by changing the beneficiary of the 529 account to a sibling or other family member.

With a Roth IRA, you contribute money after taxes—you don’t get a tax deduction like you do with a traditional IRA. But when you withdraw money, you usually don’t have to pay taxes on the earnings.

“It starts healthy habits of contributing to a retirement account,” Ms. Lucina said.

Here are some questions and answers about College 529 plans:

There is no federal tax deduction for 529 contributions, but many states offer tax credits.

Each May, many 529 plans offer promotions and prizes to encourage families to open accounts and start saving for college. For example, South Carolina is offering parents of children born in the state on May 29 $529 in grants to fund new FutureScholar 529 accounts. And California is offering families who open a ScholarShare 529 account between May 22 and 31 a $100 bonus. A list of state promotions is available at the College Savings Plans Network Website.

One option is to consider using other funds — such as taking out student loans — to pay for the first few years on campus, giving 529 businesses time to recover for later years of college or graduate school, Ms. Biar said. You could potentially pay off up to $10,000 in loans using 529 funds.

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