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Tuition Inflation Is Real Test for College-Savers

If history repeats itself, saving early can improve your odds of slaying the tuition inflation monster by about a third.

Last week, Morningstar named the best 529 college savings plans for 2018. College savings plans are without doubt the best vehicle to save for education. These plans allow investors to skip federal taxes on investment growth to pay for college and its associated costs. For many investors, that means they can avoid a 15% or 20% long-term capital-gains tax on distributions, depending on their tax bracket, to pay for education costs such as tuition, textbooks, and housing. Additionally, around half the U.S. population lives in a state that offers more tax savings at the local level.

The capital-gains tax incentive meaningfully increases the odds of beating the college tuition inflation monster. Keeping up with tuition inflation is an important consideration, particularly given how painful it can be. Over the past 10 years, college tuition inflation has averaged 4.2% a year. That’s roughly 2.5 percentage points above general inflation, as measured by the Consumer Price Index. Since 1979, tuition inflation outpaced general inflation by an average of 3.8 percentage points, so at least it’s slowed down in recent years. In fact, for the first time since 1979, tuition inflation roughly matched general inflation in 2016 and 2017. While differing views exist, many researchers expect tuition inflation to remain elevated versus broad inflation. Plus, the tuition inflation premium tends to surge in waves, so it may be due for a comeback.