The average cost of borrowing for college could be twice as much as putting money away in a 529 plan, according to a new T. Rowe Price report.
If someone were to take out the average college loan today to pay for their child’s education—$25,000—they would end up paying a total of $35,000 over the next 10 years, assuming a 6.8 percent interest rate on the loan. (The current unsubsidized rate on a Stafford loan is 6.8 percent, and subsidized interest rates are set to increase to 6.8 percent on July 1.)
But according to T. Rowe’s estimates, the person would only have had to save $17,000 for the last 15 years. That’s assuming a 6 percent earnings rate in a tax-advantaged 529 account and an annual fee of 85 basis points.
In this scenario, the monthly contributions to a 529 plan would be $100 for 15 years, versus $300 a month for 10 years to pay back the loan, said Stuart Ritter, vice president at T. Rowe Price Investment Services.
But this assumes that the plan will deliver a 6 percent return on average. And according to Morningstar, all but one Morningstar category of 529 investment options underperformed the average mutual fund in that category over the five-year period through Jan. 31, 2013. For example, the average conservative allocation 529 option returned 3.73 percent, versus 4.34 percent for the mutual fund in that category.
Yet money continues to pour into 529s. Total 529 plan assets were $180 billion as of the end of the first quarter, a 7 percent jump from the fourth quarter of last year and a 14 percent higher than the first quarter of last year, according to a new report by FRC, a division of Strategic Insight.
There aren’t a lot of other tax-advantaged options to save for college. Ritter says 529 plans are not used nearly as much as they should, because people have misconceptions about financial aid. Most financial aid, in fact, is debt, he says. According to The College Board, about 38 percent of financial aid dollars are in the form of federal loans, while the rest are in grants, scholarships, federal work-study and tax credits and deductions.