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If you don't have a 529 savings plan, you're not alone. Here's what you need to know

Simon Ritzmann

Many Americans aren't prepared as they should be when it comes to saving for college.

Working women are no exception. In a recent CNBC/SurveyMonkey Women at Work Survey, 7% of working women with children under 18 said they have at least $5,000 in a 529 College Savings Plan.

Of those who make $100,000 or more a year, 12% had at least $5,000 saved in a 529 plan. The poll surveyed 1,068 working women in the U.S. from Feb. 10 to 14.

A 529 plan allows people to save for education expenses using after-tax dollars. The money grows tax-free and can be used to pay for qualified education expenses, such as tuition, fees and books.

The lack of 529 savings may stem from a number of issues, such as misconceptions about the plans or the feeling that the anticipated expenses they address are far off in the future, said Shannon Vasconcelos, a college coach for Bright Horizons and former assistant director of financial aid at Tufts University.

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"It's easy to put off until tomorrow, especially when you are in the throes of young parenthood and overwhelmed and so busy," she said.

Concerns about market volatility, as evidenced in the last two weeks, may also keep people on the sidelines. Wednesday,  stocks plunged, putting the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite closer to entering bear-market territory.

Yet saving for college is vital, in light of soaring higher education costs. These days, the average tuition increase is 3% a year.

"You need to get your money in an account that is growing for you to keep pace with tuition inflation," said Vasconcelos.

Here's what you need to know about 529 plans and how to choose one that works for you.

529 plan vs. traditional investments

The biggest advantage to a 529 plan is the tax implications. When you take out the money for qualified expenses, you aren't taxed. If you take money out of traditional investments, you'll be taxed on any money you earned.

If your child decides not to go to college and doesn't use 529 funds towards other qualified educational expenses, such as high school tuition, others in your family can. However,  if you take the money out for anything other than those qualified expenses you'll be subject to a 10% penalty and income tax on the earnings.

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One way people work around the restrictions of a 529 plan is by saving in a Roth IRA.

"The Roth IRA tax break is really identical to the 529 in that you get the earnings of the account tax-free," Vasconcelos explained.

For older parents, this is a "win-win" since they can start taking money out of their Roth IRA when they are 59½, she said.

Those under 59½ can take out their principal balance, not earnings, without a tax or penalty.

How much you should save

If you think about saving for the entire four years of tuition, you may become too paralyzed to act.

In reality, your goal should be to save for about a third of future college costs, said Mark Kantrowitz, publisher of SavingForCollege.com. Another third would come from future college loans and a third would come from income, student financial aid and grants.

Based on that one-third rule and the cost of college today, you should be saving $250 a month for an in-state public college, $450 a month for an out-of-state public college and $550 a month for a private nonprofit college, he said.

Of course, by the time your child heads off to college, costs will be higher. You can use an online college cost calculator, like the one on SavingForCollege.com,  to get an estimate of tuition.

'Time is your biggest asset'

The sooner you start saving, the sooner you will earn interest — and then interest in your interest, known as compound interest.

"Your greatest asset is time," Kantrowitz said.

If you start saving at your child's birth, by the time he or she goes to college, about a third of your college's goal will come from earnings on your investment, he explained. If you wait until high school, it will be less than 10%.

"If you start saving in high school, you would have to save six times as much per month to reach the same college savings goal as compared to starting when your child is a newborn."

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How to choose a plan

You can get a plan through a financial advisor, which may work if you need "a lot of hand-holding" or already have a relationship with an advisor, said Kantrowitz.

However, it will cost you less if you do it yourself.

Each state offers a plan, but you don't have to choose the one offered by the state you live in or the one in which your child will attend school.

What you should do is first check to see if you get a state tax break by contributing to your own state's plan.

Also look at the fees that are charged, which will reduce your returns. You want to get the lowest fees possible.

Several plan managers "have been competing with each other to see who can charge the lowest fees," Kantrowitz said.

If you are torn between a plan with a state tax break or one with a lower fee, Kantrowitz recommends focusing on the lower fees when your child is younger. The "inflection point" is around high school. Once they are that age, the tax breaks matter more.

Another thing to consider is an aged-based asset allocation fund offered by the plan. It will start out aggressive and automatically adjust the money so that the allocations are appropriately balanced. As the start of college draws near, the portfolio should be more conservative investments, like bonds.

Limited effect on financial aid

Jacobs Stock Photography Ltd

One thing Bright Horizons' Vasconcelos often hears from parents is that if they save for college they won't qualify for financial aid.

"Saving always helps more than it hurts," she said. In fact, your aid is affected to a "very limited extent" by your 529 savings.

What usually puts parents out of range for financial aid is their income, not their savings.

While the financial aid formula is complicated, many families will be expected to contribute about 20% or 30% of their income to college each year, Vasconcelos explained.

Parents are only expected to contribute 6%, or less, of their parental savings, including 529 plans that list their child as a beneficiary.

For example, for every $10,000 you save, you'll lose out on $600 of financial aid.

"That $10,000 you save helps you pay for college much more than the $600 loss of financial aid," Vasconcelos said.

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