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529 Tips

Let The Power Of Compound Interest Help Your 529 Plan Take Off

If you’ve been to the movies, or watched a multitude of TV series recently, you’ve seen many, many superhero stories. These champions always stretch themselves to overcome obstacles and to come to others’ aid. There’s a superhero in the financial world as well, a college savings superhero – compound interest. Its super powers can really make your Ohio 529 college savings plan soar!

Able to leap over simple interest in a single bound, compound interest is dynamic powerhouse that can grow a 529 account. Here’s how.

Simple interest vs. compound interest

Simple interest is the interest on the principal only. Compound interest is the interest on the principal as well as any other accrued interest. For Ohio’s 529 Plan, CollegeAdvantage, compound interest is accumulated on the original as well as any additional 529 contributions, any earnings from the 529 investment options, and any accrued interest.

For sake of simplicity, let’s use the same numbers to create examples for a college savings account with simple interest and one with compound interest. You have contributed $10,000 to a 529 plan. The principal — or the original contribution — could grow at 5% over the next 5 years. With these examples set, we can contrast the total interest accumulated in a simple interest account to a compound interest account.

With the simple interest example, the original contribution of $10,000 with 5% will earn $500 in interest each year. Over five years, the account will total $2,500 in a simple interest account.  

With compound interest example, the original contribution of $10,000 could earn 5% for a total of $500 in interest in the first year. In the second year with compound interest, the new starting point includes the interest from the first year added to the original contribution for a total of $10,500. With 5% interest, the total interest in the second year would be $525. In the third year, the new opening amount could be $11,025, which could grow an additional $551.25 assuming 5% interest. For the fourth year, the starting amount in the example is $11,576.25. At the end of the year assuming 5% interest, the amount could grow by $578.81. In the fifth year of this example, we have an opening amount is $12,155.06. Assuming 5% interest, the account could grow by $607.75. So over five years in this scenarios, the compound interest account could grow to $2,762.81.

So, the compound interest account could earn an additional $262.81 over five years in this scenario when compared to the simple interest account. And who wouldn’t like to have those extra funds in their 529 account as they prepare to cover their student’s future higher education costs?

Compound interest with a 529 plan

For a 529 college savings plan, the compound interest is accrued not just on the original contribution but every contribution as well as the earnings from the 529 investment options and the already accumulated interest.

If you’d like to see the power of compound interest, use this calculator from U.S. Securities and Exchange Commission to input your information to see how compound interest can build up your college savings account.

The effect of compounding is especially powerful over a long period of time as the amount of earned interest grows larger and larger. This is an excellent reason to start as 529 fund as early as possible for your child – to maximize the effects of compound interest in the account. Whether you’ve started saving for your child’s higher education before they are born or if you are getting a later start, Ohio’s 529 Plan, CollegeAdvantage, offers account strategy suggestions based on your child’s age. These life milestones are the perfect opportunity to start, ramp up your saving, and take advantage of Ugift and Upromise. Based on your child’s age — baby to toddler, kindergarten to elementary school, middle school, high school, and college — review the appropriate guidance and choose for yourself the best path for your 529 account.

Loans: Where compound interest can become a villain

In a 529 plan, compound interest works for your best interests. On the flip side, accrued interest on a student loan debt can set back financial success as the interest will grow on the amount borrowed as well as unpaid accumulated interest. Taking into the consideration of the above simple vs compound interest example, imagine how accrued compound interest on a loan can accumulate. So it’s never too late or too early to start saving for your child’s future higher education costs. Any funds you can set aside in a 529 account is money your child won’t have to borrow for their education.

Additional tax benefits for saving in a 529 plan

Ohio’s 529 Plan, CollegeAdvantage, was established by Section 529 of the Internal Revenue Code to encourage parents to save their children’s future higher education costs in a tax-advantaged manner. The tax benefits of a CollegeAdvantage Direct 529 Plan account are:

  1. All earnings in a 529 plan are tax-free, so all investment growth is yours to cover college costs.
  2. 529 plan withdrawals to cover qualified higher education expenses are tax-free at federally accredited programs. These expenditures include tuition; room and board (on and off campus) when the beneficiary is enrolled at least half-time; mandatory fees; computer equipment and related technology as well as internet services; books, supplies and equipment related to enrollment and classes; and certain expenses for a special-needs student.
  3. Ohio residents who contribute to Ohio’s 529 Plan, CollegeAdvantage, can deduct their contributions from their taxable state income. Effective Jan. 1, the deduction amount is $4,000 per year, per beneficiary, with unlimited carry forward. However, $4,000 is not a contribution cap. If an Ohio taxpayer contributes more than $4,000 in one year, they can continue to subtract $4,000 per year, per beneficiary, from their State of Ohio taxable income until all the 529 contributions are deducted.

Ohio’s 529 Plan Tools and calculators

Want to crunch the numbers yourself? CollegeAdvantage has its own tools and calculators to see how your 529 savings can add up. With the college savings planner, you can input your own figures to receive an estimated monthly savings amount needed to reach your savings goals. Use this tool to vary the amounts of monthly contributions to see how setting aside a little more money can really add up. The tax benefit tool can illustrate how the tax benefits of a 529 plan can build the account when compared to a taxable savings account. The cost of waiting tool can determine how much more money you’ll need to save to reach your college savings goals if you aren’t able to maximize the power of compound interest. Your asset allocation strategy is one of the most important investment decisions to make. If you aren’t sure what level of risk you’re willing to take in your investment strategy, the risk tolerance questionnaire can determine your comfort level.

Continue to be your child’s superhero; open an Ohio’s 529 Plan account for them today for their future higher education costs. An investment in a 529 plan is an investment in your child. Every dollar saved today is a dollar that doesn’t have to be borrowed which makes Ohio’s 529 college savings plan an excellent alternative to student loan debt. Ohio’s 529 Plan, CollegeAdvantage, is your plan, your way.

Posted on July 13, 2018

Ohio Tuition Trust Authority

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