Tompor: Millennials start kids' college funds earlier than Baby Boomers did
Many Millennials who know the burdens of student debt could be aiming to treat college savings a bit differently from their parents.
After becoming parents, about 56% of Millennials began setting aside money for college for their children sometime between birth and age 5. That compares with only 33% of Baby Boomers who did that, according to the "How America Saves for College 2016" report released last fall by Sallie Mae, the private student loan giant, and Ipsos, an independent global market research company.
"They are paying attention," said Robin Lott, executive director of the Michigan Education Trust and program manager for the Michigan Education Savings Program and the MI 529 Advisors Plan.
Maybe, Lott said, some younger consumers recognize how much they benefited when their parents saved for them, or they don't want their children to be overburdened by student loans.
"Whatever it is, I applaud them," she said.
Here are some tips to consider — whether a child is in kindergarten or high school — when in comes to college savings:
1) Don't overlook tax-savvy college savings plans
While 529 college-savings plans hit a record $248 billion in assets at the end of 2016, many parents still aren't using such plans. The "How America Saves for College" study of parents with children younger than 18 noted that 61% of parents who are saving for college for their children do so with a general savings account.
By contrast, 37% of parents use the tax-favored 529 plans. Money in a 529 plan can be used toward tuition, room and board and other qualified expenses. It also can be used for undergraduate education or toward graduate degrees.
Millennial parents are more likely to use 529 plans (44%) than Gen X or Baby Boomer parents (36% and 23%, respectively), according to the study.
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The 529 industry is built on state-sponsored plans and tax breaks. Wyoming is the only state that does not have a state-sponsored 529 plan, according to the College Savings Plans Network.
There are key benefits of 529 college savings plans: 34 states and the District of Columbia offer an income tax deduction or some kind of tax credit if you save money in a 529 plan. Check the specific rules for your state. Six states — Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania — offer residents a state tax break no matter where they invest in a 529 plan, according to Young Boozer, Alabama's state treasurer and chair of the College Savings Plans Network.
In Michigan, for example, a married couple filing a joint tax return can deduct up to $10,000 in contributions to the Michigan Education Savings Program in a year on their Michigan income tax return. Up to $5,000 per year is deductible for a single-income filer. Michigan also has a plan sold through financial professionals called the MI 529 Advisor Plan. Michigan residents do not receive a state income tax deduction if they invest in a 529 plan sponsored by another state.
Michigan is one of 11 states that also offers a prepaid tuition program. One not-for-profit — the Tuition Plan Consortium — offers the Private College 529 Plan.
A college-saving plan is much like a 401(k) plan in that savers can select their own mix of investments. Typically, many parents choose age-based options that gradually reduce the amount of stocks in the portfolio as the child moves closer to college.
Leo Acheson, a senior analyst at Morningstar who tracks 529 plans, said fees on college-savings investments continue to fall. Even so, investors need to pay attention to the expense ratios and fees charged through their 529 plan. Pay attention to any annual maintenance fees that can be charged, as those fees can drive up costs, too.
Some websites allow consumers to compare plans: www.collegesavings.org and www.savingforcollege.com.
Another advantage: Money taken out of a 529 savings plan to cover qualified college expenses is tax-free on the federal and state level.
2) Prepare for higher rates on student loans
The average account balance in 529 plans is about $21,000, based on information from the College Savings Plans Network. So, most families aren't paying the full cost of college just by tapping into savings. Federal student loans remain part of the picture.
Beginning July 1, interest rates on federal student loans will increase by 0.69 percentage points. The new rate is 4.45% for undergraduate Stafford loans, 6% for Stafford loans for graduate school and 7% for the federal Parent PLUS loan.
The interest rates will apply to new loans made beginning July 1 through June 30, 2018. Rates on existing federal student loans with fixed rates will not change.
On average, undergraduates took out $4,060 in unsubsidized federal Stafford loans in 2015-16, according to Mark Kantrowitz, publisher and vice president of strategy for Cappex.com. The average annual amount was $3,727 for undergraduate subsidized federal Stafford loans.
Parents who borrowed to help their children attend college took out $14,112 in Parent PLUS loans on average in 2015-16.
Kantrowitz said he would expect the interest rates on federal education loans to increase by 0.50 percentage points to 0.75 percentage points in July 2018 if the Federal Reserve continues to raise interest rates a few more times this year and next.
3) Don't expect too much in scholarship cash
It's tempting to tell yourself that your child will get a full ride so you don't need to save. We all hear plenty of happy stories during high school graduation season. But your star high school student might be looking at $1,500 or less in scholarship cash.
Kantrowitz noted that the average scholarship — based on scholarships that are not controlled by the college — ends up being just under $4,000 a year, even though that average includes some fairly large-sized awards.
Maybe the student will be lucky enough to win the top prize of $10,000 for the "Stuck at Prom Scholarship Contest," for which he or she would create a fashionable item for the prom out of Duck brand duct tape. Or maybe students would win $5,000 for the second prize or a smaller prize.
Or maybe they'd be fortunate enough to win a $20,000 scholarship from the Coca-Cola Scholars Foundation. High school seniors with a minimum 3.0 unweighted GPA may apply on the foundation's website in August of their senior year until the Oct. 31 deadline.
Private scholarships might be from a neighborhood association, philanthropists, corporations, foundations, community foundations, 501(c)(3) organizations and others.
Kantrowitz said about $6 billion in private scholarships are awarded each year. That does not include money awarded by the college, which is just a discount on tuition, he said.
Parents need to understand that fewer than 1% of students win a completely free ride through scholarships, Kantrowitz said.
Contact Susan Tompor: stompor@freepress.com or 313-222-8876. Follow her on Twitter @Tompor.