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Should you set up a 529 college savings plan instead of a baby registry?

Should you set up a 529 college savings plan instead of a baby registry?
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Forget the baby wipes warmer and the organic onesies. Today’s parents-to-be are reconsidering the traditional baby registry items and instead asking friends and family to donate to their baby’s college fund.

Starting a 529 savings plan for a baby that is still in utero might sound odd, but considering the current cost of higher education, it might be a wise choice.

Earning a college degree in 2020 (including room, board and other fees) cost 169% more than it did in 1980, according to a report from the Georgetown University Center for Education and the Workplace (as reported by CNN). Adjusting for inflation, college tuition has increased by 747.8% since 1963, the Education Data Initiative says.

No wonder so many parents fear for their children’s educational future. A recent survey led by Discover Student Loans found that 70% of parents feel “financially unprepared” to pay for their child’s tuition this year, and 68% say that they are worried about the amount of debt their child will have to take on in order to attend college.

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What a 529 Plan Offers Your Child

Entrepreneur and author Jen Glantz decided against signing up for a baby registry and instead set up a 529 savings plan that her family and friends could then choose to support.

“Instead of stocking our small apartment with nice-to-have purchases, I decided to take a different route,” Glantz writes on Business Insider. “I told friends and family members that once the baby was born, I was going to open up a 529 account that they could choose to fund.”

A gift like this takes all the guesswork out of gifting — and is a great option for a second or third kid. Families may already have a lot of what they need, and the first child has maybe already gotten a head start on having their education paid for. Because 529 plans generate compound interest, a financial gift here can multiply and yield greater returns later on.

A 529 savings account is a state-sponsored, tax-advantaged plan that was created with education in mind. As long as the beneficiary uses the funds for education, they don’t ever have to pay taxes on their 529 earnings. In some states, contributions to 529 plans are also tax-deductible.

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And the money in your 529 plan isn’t just for college. If your child decides not to go to a traditional university, they can use it on trade schools and other alternative programs.

Plus, depending on what state you live in, you might be able to use your child’s 529 plan on their K-12 education as well. For example, Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming are among the states that allow their residents to use 529 funds for K-12 educational choices like private schools. You should check to see the rules where you live.

Cassandra Happe, an analyst for WalletHub, tells Don’t Waste Your Money that a 529 account is a smart foundational step in preparing for your child’s education.

“Initiating this account early can yield long-term benefits, leveraging the power of compounding interest to cover future costs,” says Happe. “Its potential tax advantages, including tax-deferred earnings and tax-free withdrawals for qualified expenses, make it an appealing choice.”

When setting up a 529 plan, it is important to look for an option with low fees. Sites like Saving for College offer data-based breakdowns of which 529 plan offers the lowest fees in each state. You can see where your state’s plans rank here.

Note that you don’t have to choose a plan from your state, but if you want a tax deduction or if you choose to put your funds into one type of 529 called a prepaid tuition plan, you may want to.

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Custodial Plans vs. 529 Plans

Some parents opt to create a custodial plan for their child instead of a 529 plan. The most popular of these custodial plans are UTMA or UGMA ( Uniform Transfers to Minors Act and Uniform Gifts to Minors Act, respectively).

UTMA or UGMA plans are similar to 529 plans in that they allow people to donate to a child’s future education. The main pro of custodial plans is that they offer more flexibility for your child. If they decide not to attend college, they can still use the money for other things. (With a 529 plan, you will have to pay a 10% penalty if you use the money for anything other than approved educational spending.)

With a custodial account, your child is the owner of the account and you act as the custodian if they are of age. This is a less desirable option because it means your child will have reduced options for need-based financial aid. This is because UTMA and UGMA plans will be viewed as part of your child’s financial assets, as opposed to 529 plans, which are viewed as a parent’s asset. This will reduce your child’s financial aid eligibility.

Additionally, custodial accounts do not provide any tax benefits. Account gains may be taxed at the “kiddie tax” rate if they meet a certain threshold (it’s $2,500 right now).

However, as noted above, custodial plans do give you more flexibility. With 529 plans, the money must go to your child’s education unless you want to pay a penalty. A custodial plan acts more like a traditional investment account, so you can use it for other things.

The good news is that the beneficiary of your 529 plan can be changed. For instance, if you have two children, but only the youngest winds up attending college, you can make them the beneficiary instead of your eldest.

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Funding Your 529 Plan

To start the 529 process, the first thing you need to do is pick a plan and enroll your child in it. You can do so via a financial advisor or simply do it online via a site like Edvest.

Once created, your family and friends can donate directly to your child’s 529 plan by writing a check or via electronic transfer.  Sites like UGift offer you a unique code that you can share with friends and family. This means they can easily hop online and donate to your kid’s college with just a few clicks.

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If you want to be sure that you are setting aside money for your child’s education each month, you can set up an automatic monthly transfer from your bank account to your 529 plan. Some employers also contribute directly to 529 accounts, making your 529 investing even more hassle-free.

The Downside of Asking for 529 Gifts

Although 529 plans make smart financial sense, the truth is that not everyone likes the idea of asking for money instead of gifts. In aReddit thread on whether or not it is proper etiquette to ask for 529 contributions instead of gifts, people had very mixed opinions.

“Some people want to make something homemade or to give you something meaningful,” wrote one commenter. “Personally I would find it pretentious to assume everyone can and will want to give to a college fund. You might as well send around an offering plate.”

Redditor u/iechunk noted, “I’m of the opinion no one needs to be told money is a good gift. Be warned a lot of older people see asking for monetary contributions as tacky/entitled.”

In another subreddit about the same topic, commenters once again had mixed opinions on the topic.

“Honestly, I’d be really turned off if someone ‘politely suggested’ giving their kid money,” wrote u/RawPups4  “People enjoy choosing and giving items they think you/your baby will love, and cash definitely lacks that warmth and personal connection. To me, gifts are about finding special little things that bring the receiver some delight, not funding someone’s kid’s college education.”

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Asking others to fund a custodial plan may feel even more like asking for a handout since it’s a more traditional investment account, so you may want to consider this if you plan to ask others to fund your child’s education.

Regardless of naysayers, as the price of college continues to skyrocket, asking for 529 contributions might soon become the norm rather than an anomaly.

After all, while donating to a 529 plan instead of buying a baby stroller might not feel as traditional, it can certainly have a much longer and more meaningful impact on the child’s future.

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This story originally appeared on Don't Waste Your Money.