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The Ultimate Guide to Understanding 529 College Savings Plans

Here is everything you need to know to pick the 529 plan that's best for you.

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By Kate Stalter , Barri Segal and Tanza Loudenback | Jan. 31, 2024, at 10:12 a.m.

Key Takeaways

• 529 plans are state-sponsored accounts that offer tax-advantaged savings for education expenses; they cover college, trade and vocational courses, and qualified K-12 expenses.
• Recent expansions allow 529 funds for apprenticeship programs and student loan repayments without tax consequences or penalties.
• 529 plan funds are held at a brokerage, and owners can choose investments, adjusting risk levels based on the beneficiary's age.
• Investors are not required to use their home state's 529 plan and should consider fees, investment options and tax benefits when selecting a plan.
• Some states offer state income tax deductions or credits for 529 contributions.

If you like the idea of saving for education expenses while also getting tax-advantaged investment growth, consider a 529 plan.

A 529 plan is a tax-advantaged vehicle to save for college and trade and vocational courses participating in U.S. Department of Education student aid programs. You can even apply 529 funds to qualified K-12 expenses.

While parents and grandparents are typical 529 investors, you can open an account and name yourself or anybody else as the beneficiary. The account owner maintains control over the money in a 529 account until it’s withdrawn.

What Is a 529 Plan?

Just like its cousin, the 401(k), the 529 plan gets its name from the section of the tax code that created it.

These plans are designed to finance higher education, and their main appeal lies in their tax benefits and flexibility.

[ Read: 10 Tax Credits You May Qualify for This Year ]

The key feature of a 529 plan is tax-deferred growth. Earnings are not subject to federal income tax, which can help savers pile up cash for college.

Another attractive feature is tax-free withdrawals when the proceeds go toward qualified education expenses.

You can use the money you’ve socked away for a range of qualified education expenses, including tuition, room and board, books, supplies and certain K-12 costs.

"U.S. residents of all income levels can open a 529 plan," Chris Urban, founder of Discovery Wealth Planning in McLean, Virginia, said in an email.

There are often federal or state tax advantages to saving in a 529 plan, he added.

"As long as money stays in the account, the principal and earnings will be federally tax-free, and possibly state tax-free, when withdrawn, provided the dollars are used on qualified education expenses," Urban said.

What Are Prepaid vs. Savings Plans?

You’ll find 529 accounts in two flavors, prepaid and the vastly more popular savings plans, Ashley Weeks, a wealth strategist at TD Bank in Greenville, South Carolina, said in an email.

"Funds in both 529 account types grow tax-free, and future distributions are tax-free if used for qualified education expenses," he added.

Prepaid plans, which are available only in a few states, are less flexible than savings plans.

"Prepaid tuition plans lock in future tuition at current rates through the purchase of tuition credits," Weeks said. "These plans only pay for tuition and fees at certain covered colleges and often have state residency requirements."

The main appeal of a prepaid plan is that locks in future tuition costs, which will increase with inflation at today’s prices. Students must use the funds at an in-state public college.

The 529 savings plans are more flexible, allowing beneficiaries to use the money at all qualified postsecondary schools, typically without a state residency requirement.

He added that 529 savings plans allow owners to select investments for the account and to tailor the risk level to the appropriate time horizon.

[ See: Qualified Expenses You Can Pay for With a 529 Plan. ]

How and Where Can I Spend 529 Funds?

Investors can use money from a 529 account for qualified higher education expenses, including tuition, room and board, books and supplies.

The funds can also cover up to $10,000 annually per beneficiary for K-12 education expenses.

Eligible institutions range from colleges and universities to vocational schools.

Recent expansions allow 529 funds to be used for apprenticeship programs registered with the Secretary of Labor's National Apprenticeship Act.

The SECURE Act, signed into law in 2019, allows $10,000 from a 529 plan to go toward student loan repayment without any tax consequences or penalties. In addition, $10,000 can be applied toward student loan repayment for each of the account beneficiary’s siblings.

[ Read: What Is the SECURE Act? ]

Withdrawals from 529 plans can be used internationally, Patricia Roberts, chief operating officer at Phoenix, Arizona-based Gift of College, said in an email.

"To see which U.S. and international schools have a Federal School Code, an identification number used with federal financial aid program-eligible schools, check the U.S. Department of Education's website," Roberts said.

Note that there is a 10% penalty – plus income tax – that applies when you withdraw earnings from the account for nonqualified purchases.

Understand Your 529 Investment Choices

When you open a 529 account, your funds are held at a brokerage, such as Fidelity, Schwab or Vanguard. A financial advisor can also help you open a 529 account.

Once you’ve opened the account and funded it, you’ll choose the investments, such as mutual funds or exchange-traded funds. The investment options are similar to an IRA or 401(k).

Account owners have the option of investing the funds themselves or using a manager.

Many 529 plans use an age-based formula where investments gradually become more conservative as the beneficiary gets closer to college age. For example, if you open an account for a child when they're five, you have more time to invest aggressively. When that child is in high school, a less risky investment mix will preserve capital so it’s available in a few short years when you need it.

"529 savings plans offer a range of investment choices, from conservative to aggressive portfolios," Sean Lovison, founder and lead financial planner at Purpose Built Financial Services in Moorestown, New Jersey, said in an email.

Pay Attention to Fees

Investors often overlook account fees and expenses. That can be to your detriment, as seemingly small fees can add up, making less money available for education expenses.

Charges associated with a 529 account may include:

• Enrollment fee: Some plans charge you money to get your account up and running. Not every plan has this fee.  
• Maintenance fee: Some accounts have a yearly maintenance fee. It’s typically minimal, coming in at around $50, but before opening an account, ask whether you’ll incur this charge. 
• Expense ratios: All mutual funds and ETFs have some kind of management fee. The trick is to find the lowest fees on funds that align with your objectives. "Be sure to look at each fund's expense ratio, as some states have pretty poor options, with very high fees compared to the better 529 plans," Lovison said. 
• Sales charge: A broker who’s not acting as a fiduciary can collect a commission for selling you a 529 plan. Currently, a registered investment advisor acting as a fiduciary can help clients open accounts and select investments for 529 plans sold directly through the states, but generally can’t access the account itself to manage the investments. 

How to Select the Right State Plan

All 529 education savings plans are administered by states, but it’s important to note that you’re not required to use your home state’s 529 plan. You can choose from any available plans.

"When evaluating different 529 plans, the big three considerations are fees, investment options and state tax benefits," Weeks added. "Fees vary widely between plans and the availability of low-cost funds and target date options can maximize 529 performance."

Some states provide a state income tax deduction or tax credit when residents make 529 plan contributions, Weeks said.

It’s always a good idea to run your plans by a financial advisor or tax advisor to make sure you're getting the maximum tax benefit. They may be aware of other options that may be more advantageous.

For example, Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming don’t levy a state income tax, so a 529 deduction wouldn’t be applicable.

California, Hawaii, Kentucky and North Carolina have state income taxes but do not offer an income tax deduction or credit for 529 contributions.

Those tax rules can change over time. For example, in 2022, Delaware enacted a tax deduction for 529 contributions.

Rules, Regulations and Changes

Tax laws change, which is something investors need to keep in mind. While you might think of tax changes as resulting in more money out of your pocket, that’s not necessarily true when it comes to 529 plans.

For example, the 2017 Tax Cuts and Jobs Act allowed savers to use 529 plan funds for certain K-12 expenses.

The SECURE Act of 2019 allowed 529 funds to be used toward student loan debt payoff for an account beneficiary and their siblings (up to $10,000 per person). It also allowed 529 funds to go toward books fees and equipment used in a qualified apprenticeship program.

Another change became effective in January 2024. The SECURE 2.0 Act, which was signed into law in December 2022, now allows account owners to roll a lifetime maximum of $35,000 in remaining 529 funds into a Roth IRA in the beneficiary’s name. This eases concerns about overfunded 529 accounts.

Roberts called this "a new and welcomed additional feature, subject to various conditions, however."

She pointed out that the 529 account must have been open for at least 15 years, and contributions made in the last five years are not eligible for a tax-free rollover. Also, Roth IRA rules, including annual contribution limits of $7,000, must be met.

In December 2023, there was another change to 529 withdrawal rules, specifically from accounts opened by grandparents . Previously, money from a 529 plan owned by a student’s grandparents was considered untaxed income for financial aid calculations. That sometimes reduced the amount of aid for which a student qualified.

Under the new rules, questions about cash gifts from grandparents have been removed from the Free Application for Federal Student Aid. The new FAFSA applications were launched in December 2023 in time for the 2024-25 academic year.

[RELATED: How to Roll Over Funds From a 529 College Savings Plan to a Roth IRA ]

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College Savings 101

Use this section to learn about 529 plans and other ways to save and pay for college. From determining college costs and learning about financial aid to opening a 529 plan, the resources on this page are sure to help you get started with your college savings journey.

• Compare college savings options
• How much financial aid can you get?
• What does college cost?
• College Savings Tutorial

Introduction to 529 Plans

Find answers to the most commonly asked questions investors have about 529 plans.

• What is a 529 plan?
• Are 529 plans only for public colleges?
• Name the top 7 benefits of 529 plans
• Does a 529 plan affect Financial Aid?
• What is the penalty on an unused 529 plan?
• Are there estate tax benefits for 529 plans?
• Can I have 529 plans from multiple states?
• Which is the best 529 plan available?

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Understanding the 4 Key 529 Plan Fees and Expenses

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Understanding College Savings Accounts

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Figuring out how to pay for college can be a challenging task, and many families start saving up well in advance. Designated college savings accounts, which encourage you to build up your college fund by offering incentives and rewards, are a popular tool that families use to build and manage savings intended for college.

Whether you already have a college savings account or your family is considering opening one, here’s what you need to know to better understand how creating a savings account will affect your college choices.

What is a college savings account?

A college savings account is a bank account with a twist: It’s specifically set up to handle the task of saving money for college. College savings accounts are usually set up by your parents or guardians in your name, but some also allow others to contribute to them as well. The most popular forms of college savings accounts are the 529 plan and the Education Savings Account, both of which we’ll describe in detail below.

Typically, these accounts offer incentives to encourage you to use that money only for educational expenses. These might include rewards like tax breaks, or penalties that discourage account holders from withdrawing money for other purposes.

Of course, it’s possible for your family to use a different kind of bank account, such as a regular savings account or a Roth IRA, to hold the money you’re planning to use for college. (Savings bonds are another option, but they function differently and don’t fall under the heading of college savings accounts.) This approach is potentially more flexible; for instance, it might allow you to more easily withdraw funds if you encounter an unforeseen emergency.

However, if your family doesn’t use a designated college savings account, you’ll miss out on the special benefits that come with it. You might also be more tempted to make withdrawals for non-educational reasons, even if it’s not an emergency. For these reasons, there are many families who choose to use college savings accounts.

How does a college savings account work?

On one level, college savings accounts work on a simple principle. The account is started by the account custodian, often your parent, with you listed as the beneficiary. Your family members, you yourself, or others in your life contribute money to that account over time.

The money you accumulate in college savings accounts is invested, and your account may accrue interest over time, increasing its value. Once you get to college, you can use the contents of your college savings account(s) to help pay for costs like tuition .

In practice, however, having and using a college savings account is somewhat more complicated. Different types of accounts have different requirements and restrictions, so you’ll have to do some research to determine the policies of your specific plan. If your family is considering starting one of these accounts, a broker or financial advisor can help you decide which type of plan is best for you.

Below, we’ll go over the basics of the two most common types of college savings accounts, including their benefits, their restrictions, and how to use them. We can’t cover every detail in this short post, but this information will help get you started.

Formally known as “qualified tuition plans,” these college savings accounts were created under section 529 of the Internal Revenue Code, hence their colloquial name. There are two major types of 529 plans, and depending where you live, you may have several different options.

The first type of 529 plan is the prepaid tuition plan. In this plan, your family will basically be able to use the money you save for college to prepurchase units of tuition from certain eligible colleges. This locks in your tuition rate, meaning that if tuition rises in the future (as it usually does), your family will have saved money by prepaying.

Typically, a 529 prepaid tuition plan can only be used for tuition and mandatory fees. Prepaid tuition plans also come with residency and age restrictions, and you can only enroll at certain times of the year.

The second type of 529 plan, the college savings plan, is somewhat more flexible. It creates a savings account that you can eventually use to cover tuition as well as certain other college expenses , such as housing and books. Not only can it be used for a wider range of expenses than a prepaid tuition plan, it can be used at a much larger number of colleges.

One downside of the 529 college savings plan is that unlike the prepaid tuition plan, it doesn’t let you lock in a lower rate for tuition. Another is that your investment isn’t guaranteed, meaning that the amount of interest you earn depends upon market conditions, and your 529 plan might even decline in value.

Both types of 529 plans provide tax benefits; for instance, contributors won’t pay federal income taxes on income placed in a 529 plan. If the account custodian withdraws money for a use besides qualified educational expenses, they’ll have to pay those taxes and an additional penalty at that time.

Educational Savings Accounts (ESAs)

ESAs, which are sometimes called Coverdell accounts, are similar to 529 plans in many ways — they allow your family to save up money for educational expenses while receiving incentives like tax advantages. However, there are a few key differences.

The defining feature of ESAs is that they can be used not only for college expenses, but also for educational expenses at primary and secondary schools. Your family could choose to withdraw funds from your ESA without a penalty to pay for private school tuition, uniforms, or certain other costs.

Some families may like the fact that ESAs provide you with more decision-making power regarding the investments upon which your account relies. (529 plans offer only a few choices.) The account custodian can choose to invest your funds in almost anything, and a good investment strategy could substantially increase the value of your account.

However, ESAs are also restricted in certain ways that 529 plans aren’t. For instance, contributions to your ESA are no longer accepted after you reach age 18, and you must use your ESA funds before you reach age 30.

ESAs also place significant limits on contributions. No matter how many ESAs are set up in your name and how many different people contribute to these ESAs, the total contribution to ESAs in your name each year can be no more than $2,000. 529 plans generally don’t have these limits, so they may be a better option if you anticipate larger contributions.

How do college savings accounts affect financial aid awards?

When you’re looking at forms of funding for college that are strictly merit-based and don’t consider your financial need, your college savings account doesn’t matter. Many scholarships , for instance, don’t take into account your ability to pay when determining awards (though some do).

When it comes to need-based financial aid , however, the assets you and your family already have matter quite a bit. Since a college savings account represents an asset on the part of the account custodian, usually your parent, it will be taken into account when calculating your financial need.

Simply put, money that your family has saved in your college savings account is money that your family doesn’t need to get from another source. If you have a college savings account, your financial need will be judged to be less than if you didn’t have that account.

At colleges that award financial aid based upon need, this will generally mean that you receive less aid. The same is true when it comes to need-based aid received from the federal government (including subsidized Federal Direct student loans ) or from those scholarships and outside programs that consider financial need.

How much of a difference your college savings account will make in your financial aid award really depends upon how much money you have saved in that account. Just as with any other savings account or asset, the more you have, the greater the impact will be.

Something to keep in mind is that under current regulations, a college savings account is treated as an asset of the account custodian, not as an asset of the beneficiary (you). This may seem like a small difference, but it’s actually significant. Most need-based financial aid policies require students to contribute a larger proportion of their assets than their parents, so putting your money into a designated college savings account administered by your parent will likely affect your potential financial aid less than if you held that money in your own account.

Every college has slightly different financial aid policies, and these policies change over time. Speaking directly to the college’s financial aid office is the best way to determine exactly how your college savings account will impact your financial aid award at that specific school.

Is it worth it to start a college savings account?

Each family has a different financial situation, and there’s a fair amount of variation among different college savings account plans, so the answer to this question will be different for everyone. A professional financial advisor or broker will be able to give you the advice that’s most appropriate to your situation, but here are some factors to consider.

Having a college savings account involves paying fees, so cost can be an issue in deciding whether to open one of these accounts. You’ll need to be an informed consumer, research these fees, and decide whether they’re manageable in your situation. The amount of money you’ll save may or may not be enough to justify the fees involved and the hassle of creating a new account.

Timing is also important. The younger you are , the more potential setting up a college savings account has to benefit you. If you’re already in 11th or 12th grade, you’ll have less time to reap the benefits, and you may decide it’s not worth your time and money.

Finally, personal factors can come into play. For instance, if your family situation is more complicated than the stereotypical nuclear family, a college savings account with multiple contributors can potentially be an effective way to designate one central location for your college savings. Only you and your family can decide whether a college savings account is the most appropriate solution for you, but it’s certainly an approach that makes sense for many students.

For More Information

To learn more about your responsibilities and options when it comes to paying for college, check out these posts from the CollegeVine blog :

• Tuition vs. Total Cost of Attendance: Understanding Your College Expenses
• What You Need to Know for a Successful Scholarship Season
• How Do I Get Started Saving Money for College?
• 15 College Financial Aid Resources

Curious about your chances of acceptance to your dream school? Our free chancing engine takes into account your GPA, test scores, extracurriculars, and other data to predict your odds of acceptance at over 500 colleges across the U.S. We’ll also let you know how you stack up against other applicants and how you can improve your profile. Sign up for your free CollegeVine account today to get started!

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10.2 Savings, Expenses, and Budgeting

Questions to Consider:

• How is the flow of money best measured?
• How do I keep things balanced?

“Do not save what is left after spending; instead spend what is left after saving.” —Warren Buffett 6

What is the best way to get to the Mississippi River from here? Do you know? To answer the question, even with a map app, you would need to know where you are starting from and exactly where on the river you want to arrive before you can map the best route. Our financial lives need maps, too. You need to know where you are now and where you want to end up in order to map a course to meet the goal.

You map your financial path using a spending and savings plan, or budget, which tracks your income, savings, and spending. You check on your progress using a balance sheet that lists your assets , or what you own, and your liabilities , or what you owe. A balance sheet is like a snapshot, a moment in time, that we use to check our progress.

The term budget is unpleasant to some people because it just looks like work. But who will care more about your money than you? We all want to know if we have enough money to pay our bills, travel, get an education, buy a car, etc. Technically, a budget is a specific financial plan for a specified time. Budgets have three elements: income, saving and investing, and expenses.

Income most often comes from our jobs in the form of a paper or electronic paycheck. When listing your income for your monthly budget, you should use your net pay , also called your disposable income. It is the only money you can use to pay bills. If you currently have a job, look at the pay stub or statement. You will find gross pay , then some money deducted for a variety of taxes, leaving a smaller amount—your net pay. Sometimes you have the opportunity to have some other, optional deductions taken from your paycheck before you get your net pay. Examples of optional deductions include 401(k) or health insurance payments. You can change these amounts, but you should still use your net pay when considering your budget.

Some individuals receive disability income, social security income, investment income, alimony, child support, and other forms of payment on a regular basis. All of these go under income. During school, you may receive support from family that could be considered income. You may also receive scholarships, grants, or student loan money.

Saving and Investing

The first bill you should pay is to yourself. You owe yourself today and tomorrow. That means you should set aside a certain amount of money for savings and investments, before paying bills and making discretionary, or optional, purchases. Savings can be for an emergency fund or for short-term goals such as education, a wedding, travel, or a car. Investing, such as putting your money into stocks, bonds, or real estate, offers higher returns at a higher risk than money saved in a bank. Investments include retirement accounts that can be automatically funded with money deducted from your paycheck. Automatic payroll deductions are an effective way to save money before you can get your hands on it. Setting saving as a priority assures that you will work to make the payment to yourself as hard as you work to make your car or housing payment. The money you “pay” toward saving or investing will earn you back your money, plus some money earned on your money. Compare this to the cost of buying an item on credit and paying your money plus interest to a creditor. Paying yourself first is a habit that pays off!

Pay yourself first! Put something in savings from every paycheck or gift.

Expenses are categorized in two ways. One method separates them into fixed expenses and variable expenses. Rent, insurance costs, and utilities (power, water) are fixed: they cost about the same every month and are predictable based on your arrangement with the provider. Variable expenses, on the other hand, change based on your priorities and available funds; they include groceries, restaurants, cell phone plans, gas, clothing, and so on. You have a good degree of control over your variable expenses. You can begin organizing your expenses by categorizing each one as either fixed or variable.

A second way to categorize expenses is to identify them as either needs or wants. Your needs come first: food, basic clothing, safe housing, medical care, and water. Your wants come afterward, if you can afford them while sticking to a savings plan. Wants may include meals at a restaurant, designer clothes, video games, other forms of entertainment, or a new car. After you identify an item as a need or want, you must exercise self-control to avoid caving to your desire for too many wants.

List the last ten purchases you made, and place each of them in the category you think is correct.

How do your total “need” expenses compare to your total “want” expenses? Should either of them change?

Budgets are done in a chart or spreadsheet format and often look like the ones below. Pay attention to how the first budget differs from the second.

Balancing Your Budget

Would you take all your cash outside and throw it up in the air on a windy day? Probably not. We want to hold on to every cent and decide where we want it to go. Our budget allows us to find a place for each dollar. We should not regularly have money left over. If we do, we should consider increasing our saving and investing. We also should not have a negative balance, meaning we don’t have enough to pay our bills. If we are short of money, we can look at all three categories of our budget: income, savings, and expenses.

We could increase our income by taking a second job or working overtime, although this is rarely advisable alongside college coursework. The time commitment quickly becomes overwhelming. Another option is to cut savings, or there’s always the possibility of reducing expenses. Any of these options in combination can work.

Another, even less desirable option is to take on debt to make up the shortfall. This is usually only a short-term solution that makes future months and cash shortages worse as we pay off the debt. When we budget for each successive month, we can look at what we actually spent the month before and make adjustments.

Tracking the Big Picture

When you think about becoming more financially secure, you’re usually considering your net worth , or the total measure of your wealth. Earnings, savings, and investments build up your assets—that is, the valuable things you own. Borrowed money, or debt, increases your liabilities, or what you owe. If you subtract what you owe from what you own, the result is your net worth. Your goal is to own more than you owe.

When people first get out of college and have student debt, they often owe more than they own. But over time and with good financial strategies, they can reverse that situation. You can track information about your assets, liabilities, and net worth on a balance sheet or part of a personal financial statement. This information will be required to get a home loan or other types of loans. For your net worth to grow in a positive direction, you must increase your assets and decrease your liabilities over time.

Assets (Owned) – Liabilities (Owed) = Net Worth

Analysis Question

Can you identify areas in your life where you are losing money by paying fees on your checking account or interest on your loans? What actions could you take to stop giving away money and instead set yourself up to start earning money?

Get Connected

You can write down your budget on paper or using a computer spreadsheet program such as Excel, or you can find popular budgeting apps that work for you. 7 Some apps link to your accounts and offer other services such as tracking credit cards and your credit score. The key is to find an app that does what you need and use it.

Here are some examples:

• 6 Buffett, Warren. The Essays of Warren Buffett: Lessons for Corporate America. 1991. Cardozo Law Review.
• 7 http://www.techtimes.com/articles/80726/20150902/best-budgeting-apps-for-college-students-mint-you-need-a-budget-and-more.htm

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• Publication date: Mar 27, 2020
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• Book URL: https://openstax.org/books/college-success/pages/1-introduction
• Section URL: https://openstax.org/books/college-success/pages/10-2-savings-expenses-and-budgeting

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UNDERSTANDING COLLEGE SAVINGS PLANS

The following is adapted from a joint publication by NASAA; the  College Savings Plan Network , an affiliate of the National Association of State Treasurers; and the  Investment Company Institute , the national association of the investment company industry. Click  here  to download a PDF version of the full brochure.

Ways to Save for Education

To encourage greater savings for higher education expenses, federal and state lawmakers have developed innovative programs, such as qualified tuition programs, to make higher education financially accessible to more Americans.

In recent years, growing numbers of families have taken advantage of qualified tuition programs, commonly known as “529 plans” for the section of the tax code that authorizes them, as a way to help finance the future qualified higher education expenses of their children or grandchildren.

There are two types of 529 plans:

• prepaid tuition plans, which are set up to allow an individual to prepay a student’s future tuition and fees at today’s rates; and
• college savings plans, which allow individuals to contribute to an account established to pay a student’s qualified higher education expenses at any eligible educational institution.

Today, 49 states and the District of Columbia offer college savings plans and 17 states offer prepaid tuition plans. In addition, a group of close to 300 private U.S. colleges and universities offers a prepaid tuition program called the Independent 529 Plan, which allows investors to purchase discounted tuition at any of the colleges and universities that participate in the program.

College Savings Plans

College savings plans allow individuals to contribute to an account to pay a beneficiary’s qualified higher education expenses, such as tuition, fees, books, supplies, and room and board. The value of college savings plans is based on the performance of the particular investments or investment strategy chosen by the contributor. As a result, college savings plans generally carry investment risk, which means the account value may increase or decrease depending on market conditions.

Contributions to college savings plans have been growing as the public becomes aware of their desirability as savings vehicles. For example, a survey of state plans indicates that assets held in 529 savings plans grew from $2.6 billion at year-end 2000 to $35.1 billion at the end of 2003. The asset growth was mostly attributed to an increase in the number of accounts, which rose to more than four million.

Many mutual fund companies manage college savings plans for states, and mutual funds are the most commonly used investment vehicle in these plans. At the end of 2003, 97 percent of 529 savings plan assets were invested in mutual funds. Each state’s plan typically offers more than one investment option. These options typically include a portfolio of stocks and bonds whose percent composition changes automatically as the beneficiary ages; a portfolio with fixed shares of stocks and bonds; or individual portfolios with varying investment strategies.

Prepaid Tuition Plans

Prepaid tuition plans allow a parent, grandparent, or family friend to establish an account in the name of a student to “lock in” the cost of a specified number of academic periods or course units in the future at current prices, typically at the public colleges and universities located in the state sponsoring the program. For example, if an account holds shares worth two years’ tuition, these shares will always be worth two years’ tuition even several years later when tuition rates may have doubled. The account may be funded by a lump sum or periodic cash payments.

There are two main types of prepaid tuition plans – prepaid units and contracts. Prepaid unit plans sell units representing a fixed percentage of tuition. While the price of a unit may increase each year, once purchased, the unit remains valued at the same percentage of tuition it had when originally purchased. Under a contract plan, participants agree to purchase a specified number of years of tuition and mandatory fees and/or room and board. The purchase price depends on the age of the child, the type of payment (lump sum or installment), and the number of years or units purchased. Contract plans usually offer lower prices for younger children because the state has more time to invest the money.

Prepaid tuition plans provide a hedge against tuition inflation and enable the state to pool money to make long-range investments so that the earnings meet or exceed college tuition increases. Most prepaid tuition plans also have some type of guarantee from the state, ranging from full faith and credit obligations to a statutory guarantee. The specifics of prepaid tuition plans vary greatly from one state to another.

Income Tax Considerations

Contributions to 529 plans are made with after-tax dollars and any earnings grow tax-free at the federal level. Earnings withdrawn from 529 plans to pay for qualified higher education expenses are free from federal income tax for state-sponsored programs and programs of any eligible higher education institution. (The tax-free withdrawal provisions are scheduled to lapse in 2010 unless renewed by Congress.)

State-tax treatment of college savings plan contributions, earnings, and withdrawals vary from one state to another. A number of states allow residents who participate in their own state’s plan to claim a partial or full state income tax deduction on contributions. In addition, many states provide residents with a state tax break on earnings distributions from 529 plans that are used to pay qualified college expenses. Check with your tax advisor for your state’s tax treatment of contributions to, and earnings distributions from, both in-state and out-of-state 529 plans.

Selecting a 529 Plan

No two 529 plans are exactly alike. Before selecting either a prepaid tuition plan or a savings plan, you should consider what type of plan best suits your needs and obtain copies of its offering documents, which are provided free of charge by the plan and discuss the plan’s features in detail. Rather than obtaining documents for just one plan, you may want to examine documents for a number of different plans, including those offered by your home state because they may offer benefits not available in another state’s program. Doing so will enable you to compare the features offered by each of the programs and determine which plan best suits your needs. An excellent source for these materials is the College Savings Plans Network (CSPN) .

Some investors may even consider both kinds of plans – a prepaid plan to cover tuition and fees and a savings plan to pay for additional expenses, such as room and board, books, and required supplies and equipment in connection with a postsecondary education.

Investors with questions about any of the plan’s features should contact the state or the plan sponsoring the program. Most plans offer toll-free phone numbers to assist investors. Contact information for each of the states is available through the CSPN website .

When considering opening a 529 account you may want to consult with a financial adviser. If you consult with a financial adviser, you should ask whether the adviser has a relationship with any particular plan he or she is recommending. You also should be sure to ask an adviser about the plans offered by your home state to ensure that the plan you ultimately select is the plan that best suits your needs. If your financial adviser does not recommend your home state’s plan, you should obtain and review information on your home state’s plan before making an investment decision.

Selecting a 529 Plan: “Checklist” Use this checklist to compare the features of different 529 plans. All of this information is readily available from the offering documents each plan provides.

• Who may open the account?
• Is there any limit on who qualifies as an eligible beneficiary?
• Are there any age requirements for the account owner or beneficiary?
• Can I change the account beneficiary? If so, are there any fees assessed by the plan for the change?
• Is the plan available to residents in my state?
• At which colleges, universities, or vocational schools may withdrawals be used? (For example, if the 529 plan is a prepaid tuition plan there may be limits on the institutions whose tuition is covered in full.)
• Do I have to name a specific school when buying a prepaid tuition plan? If the plan is school-specific, what happens if the student decides to attend a different school or isn’t admitted by the school?
• Are prepaid tuition benefits guaranteed by the state?
• How are prepaid plan benefits indexed to tuition inflation? Are they guaranteed to equal actual tuition increases, the state average increase, or a projected increase?
• Does the plan impose any minimum contribution requirements?
• Is there a limit on how often I can invest in the account or on how much I can annually invest in the account?
• What is the maximum amount that I can invest in the account over the life of the account?
• What expenses are covered by plan withdrawals?
• What is the plan’s refund policy?
• Are there any special incentives for state residents?
• What fees are associated with my account?
• Is there an account minimum I must maintain to avoid certain fees?
• Can I buy the plan directly from the state or plan sponsor, or must it be purchased through a broker-dealer?
• If I purchase the plan through a broker-dealer, will the broker-dealer impose any additional fees in connection with opening the account?
• Can I change how my money is invested?
• If I consult with a financial adviser, what relationship, if any, does that adviser have with the plan he or she is recommending?
• What investment options are offered by the plan?
• What are the risks associated with each of the investment options?
• Are any of the investment options “age-based” such that the portfolio will be automatically adjusted as the beneficiary gets older?
• What has been the performance of the various investment options offered by the plan?
• Does my state offer any tax advantages for either contributions made to the account or withdrawals from the account?
• Does the plan limit how soon I can begin taking withdrawals from the account?
• Does the plan impose any penalties for withdrawals from the account or impose any account termination fees?
• What customer services does the plan provide (toll-free phone numbers, online account information, regular bulletins or mailings)?
• What happens to existing investments and future investments if the investment manager is changed by the state?
• What if my child does not pursue a postsecondary education?

Frequently Asked Questions

Are prepaid tuition plans and college savings plans different? Yes. With a prepaid tuition plan, parents, grandparents, and others essentially “lock in” today’s tuition rates, and the program will pay out future college tuition at any of the state’s eligible colleges or universities (or a payment to private and out-of-state institutions). A college savings plan is an investment program that allows participants to invest in a special account designated for qualified higher education expenses. In general, college savings plans offer a rate of return that depends on the performance of the plan’s investments. As such, the value of a college savings plan account may increase or decrease over time.

How much can be contributed to a 529 plan? Each state sets its own contribution limit under federal regulations. For a prepaid tuition plan, the maximum contribution is the amount necessary to prepay the number of years or units of tuition offered by the state. This amount will vary from state to state. A majority of states with college savings plans have maximum contribution limits of more than $200,000. These limits also may be adjusted annually for inflation. In 2004, individuals can contribute up to $55,000 in one year for each beneficiary – or $110,000 from married couples – without incurring federal gift taxes, as long as no further gifts to or for that individual are made during the next five years.

Who can contribute to 529 plans? Generally an account holder can open an account on behalf of any student or potential student. For example, grandparents can save on behalf of grandchildren. Even someone who is not a family member can open a 529 plan account for an unrelated child or adult.

Can I open more than one account in the name of the same student? Yes. You can open multiple accounts for the same student, and more than one person can contribute to a college savings plan for the same beneficiary. However, a state’s maximum contribution limit would limit the total amount that may be invested for a single beneficiary under that state’s program, regardless of how many accounts are held in the beneficiary’s name.

Do 529 plans vary from state to state? Yes. Each state with an existing plan offers various investment options specifically designed to save for education expenses. Determining which plan to invest in will depend on individual circumstances, taking into account several factors associated with the programs, such as fees, expenses, investment options, and performance. In addition, investing in the plan offered by an individual’s own state might lower that individual’s state income tax burden, depending on the laws of the state. Participants may transfer 529 assets from one state’s plan to another, tax-free, once every 12 months, or more often if there is also a change to the account’s beneficiary.

Can I have more than one student in a single account? No. When you invest in a college savings plan or prepaid plan you are investing on behalf of a designated individual beneficiary. You can transfer your account to any member of the beneficiary’s family, as defined by the Internal Revenue Service, without incurring any taxes or penalties.

When can a 529 plan be opened? The answer depends on the type of 529 plan being opened. A college savings plan generally can be opened anytime after a child is born. Most prepaid tuition plans, however, have a set enrollment period established by the state during which new accounts may be opened and have age limits for the beneficiary.

Where can 529 college savings plan withdrawals be used? Withdrawals from 529 savings plans can be used to pay for qualified higher education expenses at any college, university, vocational school, or other accredited postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. This includes virtually all accredited public, nonprofit, and privately owned profit-making postsecondary institutions.

What expenses can 529 plan withdrawals be used for? Withdrawals from 529 savings plans can be used penalty-free only to pay for qualified higher education expenses, such as tuition and fees; the cost of books, supplies, and other equipment; and in some situations the cost of room and board. (The cost of room and board may be a qualified higher education expense if the designated beneficiary is enrolled at least half time at an eligible educational institution.) Section 529 prepaid tuition plans typically cover tuition and required fees. Unlike the Independent 529 Plan, some states’ prepaid plans may also cover room and board.

What if my child does not pursue a postsecondary education? You may request a refund, and the account will be refunded according to the policy of your specific 529 plan. For 529 savings plans, the refund would include any earnings in the account. Under federal law, there may be income tax consequences including a refund penalty of 10 percent, except in the case of the student’s death, disability, or receipt of a scholarship. In lieu of requesting a refund, you may choose either to hold the 529 plan investment until a later date when the student may decide to attend college, or transfer the benefits to another member of the student’s family.

Will 529 savings plans affect a student’s chance to qualify for financial aid? Financial aid treatment of investments changes through the years so it is impossible to know how assets will be treated in the future. Typically, however, any investment may impact a student’s eligibility for need-based financial aid. In addition, it is uncertain as to how much or what types of financial aid will be available to families in the future. You should contact the financial aid office of your local college or university for specific information on its financial aid treatment of 529 accounts.

What happens if I move from one state to another? You have a choice of leaving your money in the existing plan or rolling it over into the plan of your new state. Assets of one 529 plan can be transferred tax-free to another 529 plan for the same beneficiary once during a 12-month period. There may, however, be state tax implications when you transfer from one 529 plan to another. Also, if you decide against changing plans after moving, you may lose any state tax deduction on future contributions and state tax exemptions on withdrawals made to the plan offered by your former home state. (The money invested will still grow tax-deferred.) Your new state also may offer favorable tax treatment for investments made in its plan. As a result, when moving, you should investigate the tax implications of each state’s plans. An account owner does have the option of establishing accounts in more than one state for the same beneficiary.

Where can I find more information on 529 plans? Many mutual fund company websites provide information on education savings programs they offer. Individuals seeking additional information on prepaid tuition plans and college savings plans may want to visit the website of the College Savings Plans Network, an affiliate of the National Association of State Treasurers, at www.collegesavings.org. Additional information about 529 plans and their regulation is available through the websites of the Municipal Securities Rulemaking Board (www.msrb.org), which regulates the offer and sale of such plans, and of the NASDR (www.nasdr.org), which regulates broker-dealers.

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What Is Saving?

Pros and cons of saving, what is investing, pros and cons of investing, when to save and when to invest, the bottom line.

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Saving vs. Investing: What Teens Should Know

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Saving vs. Investing: An Overview

Understanding the difference between saving and investing is essential to ensure financial security and a bright future. Though these terms are sometimes used interchangeably, it is important to note that they are very different. Both savings and investing are critical elements of personal finance, and starting early is a great way to set oneself up for long-term financial stability.

In this article, we will cover what saving is, what investing is, and the pros and cons of each, along with examples to help understand these concepts better.

Key Takeaways

• Saving money means storing it safely so that it is available when we need it and it has a low risk of losing value.
• Investment comes with risk, but also the potential for higher returns.
• Investing typically often comes with a longer-term horizon, such as for children's college funds or one's retirement.
• Both saving and investing are key pieces to one's personal finances.

People save money for both purchases and in case of emergencies. Saving is an essential part of personal finance that involves setting aside money for future use. Think of it as putting your money in a piggy bank, but instead of an actual piggy bank, you can use a savings account or a certificate of deposit (CD) that earns interest over time. You can save for different reasons, such as buying a new gadget, going on a vacation, or having an emergency fund for unexpected expenses.

Saving is an excellent way to meet short-term financial goals and prepare for unexpected situations, such as a car repair or medical bills By putting aside money regularly, you can build up a cushion that can help you weather tough times. Savings are generally low-risk, meaning your money is safe, but the interest rates received are also low.

Generally speaking, short term is considered to be periods of around one year or less. Keep in mind when you will need funds, what your plan is for the funds, and the safety/risk associated with the goal.

One example of saving is setting aside a portion of your allowance or paycheck into a savings account every month. Let's say you want to save $1,000 for a new laptop, and you have ten months to do so. By setting aside $100 each month, you can reach your goal without having to pay interest on a loan or a credit card.

You can also use automatic transfers to ensure that you save consistently without having to remember to do so manually.

Saving has many benefits such as providing a financial safety net for unexpected events, liquidity for purchases and other short-term goals, and being safe from loss. However, there are also some drawbacks to consider, such as missing out on potential higher returns from riskier investments. Savings can also lose purchasing power caused by periods of rising inflation .

While saving is a crucial part of any financial plan, it's essential to combine it with other forms of investing, such as retirement accounts or investing in the stock market, to achieve a balanced approach to financial planning.

Builds up an emergency fund

Funds short-term goals like buying groceries, a new phone, or going on a vacation.

Minimal risk of loss. Savings held at banks are protected by FDIC.

Much lower yields

May lose out to inflation

Opportunity costs when not invested in riskier but higher yielding assets

Investing is a way to grow your money over time by putting it to work in financial instruments such as stocks , bonds , and mutual funds . Unlike saving, investing involves taking on some risk, but it also has the potential to earn higher returns over the long term.

Investing is a way to reach long-term financial goals, such as saving for college, a down payment on a house, or retirement. Because investing involves taking on some risk, it's essential to choose investments that align with your goals, risk tolerance, and time horizon. In general, the longer you can invest, the more risk you can take on, because you have more time to ride out the ups and downs of the stock market.

For instance, let's say you want to invest in a company like Apple. By buying shares of its stock, you own a tiny piece of the company and can benefit from its growth and profits. If Apple performs well, the value of its stock could increase over time, allowing you to sell it for a profit.

One important thing to remember is that investing comes with no guarantees, and there is always the risk of losing money. For example, if Apple were to go bankrupt, your investment could be almost worthless. That's why it's essential to diversify your portfolio by investing in different companies and industries to reduce your risk.

Using a 401(k) retirement plan is a good example of investing as it involves setting aside a portion of your income to invest in a diversified portfolio of stocks, bonds, and other financial instruments with the goal of growing your savings over time.

A 401(k) plan is a type of retirement account offered by many employers as a benefit to their employees. You contribute a percentage of your salary to the plan, and your employer may match your contribution up to a certain amount. The money you contribute to the plan is then invested in a portfolio of mutual funds, stocks, and bonds that are chosen by the plan administrator.

The key advantage of using a 401k retirement plan is that it offers tax benefits. The money you contribute is deducted from your taxable income, meaning you pay less in taxes. Additionally, the investments in your 401k grow tax-deferred , which allows your money to grow tax free over time and potentially earn higher returns than a traditional savings account. Taxes are not due until you start drawing money from the account.

Investing in a 401(k) plan highlights the importance of starting to save for retirement as early as possible. By investing consistently over time, you can benefit from compounding returns and potentially grow your retirement savings significantly. It's also important to choose a mix of investments that align with your risk tolerance and retirement goals, and to regularly review and adjust your investments over time to ensure they continue to meet your needs.

Financial experts do not recommend keeping very much of an investment portfolio in cash, because it can create " cash drag " and lower the potential returns of your portfolio.

Investing has the potential for higher returns than savings accounts, the ability to grow your wealth over time through compounding and reinvestment, and the opportunity to help you achieve long-term financial goals, such as saving for retirement or buying a house.

However, there are also some cons that should be considered. Investing always involves some level of risk, and there is no guarantee that you will make money or even get back what you've invested. Diversification across several holdings can help. It's important to do your research and understand the potential risks associated with different types of investments. Investing requires discipline and a long-term perspective, which can be difficult for some people to maintain in the face of market volatility or the temptation to follow the crowd in an attempt to make quick profits.

Potential for higher returns than savings

Can help achieve long-term financial goals

Diversification can reduce risk

Risk of loss, especially in the short-run

Requires discipline and commitment

May require longer time horizons

One of the most common questions that people ask is whether they should save or invest their money. The answer to this question will depend on your particular financial situation, goals, and risk tolerance.

When you are young, you may have limited income and expenses, but it's never too early to start thinking about saving and investing. In fact, starting early can give you a significant advantage in building wealth over time. Investing can help you fulfill long-term goals, such as saving for college or retirement. As a young person, you have time on your side, which means you can take more risks and invest in riskier assets. Even if you suffer losses in the short-term, you have more flexibility to recover and benefit from the positive effects of long-term investing. In other words, by investing early and regularly, you can take advantage of the power of compounding, which means your money can grow exponentially over time.

As you get older and have a shorter time horizon , experts recommend shifting out of riskier assets like stocks and into more conservative ones like bonds and cash. This is because short-term volatility is more of a potential risk if the market crashes just as you're about to retire.

Even for younger individuals, saving is generally a good idea if you have short-term goals, such as saving for a new phone, laptop, or a vacation. Saving means putting your money into a safe and low-risk account, such as a savings account, money market account , or a certificate of deposit (CD). Savings products generally offer low returns but they also come with low risk. They are a good option if you need to access your money in the near future and can't afford to lose any of it.

Investopedia / Alice Morgan

Before you put any money into investments, be sure to have enough savings put away in an emergency fund to cover several months of expenses, and enough money in your savings account to cover all of your short-term needs like bills, rent, and groceries.

Which is riskier, saving or investing?

By definition, saving entails very little risk. Investing, on the other hand, comes with the risk of losing money. Therefore, investing, in general, is riskier than saving.

Why do some people prefer to save rather than invest?

Some people may choose to save rather than invest for a variety of reasons. Some people prefer the sense of security of having more money set aside in a savings account for unexpected expenses or emergencies. Others may have a larger number of short-term financial goals, such as saving for a vacation or the down payment on a house, and prefer to keep the money in a low-risk savings account. Additionally, some people may not have the knowledge or expertise to invest, or they may not feel comfortable with the level of risk associated with investing due to having a low risk tolerance . Finally, some people may simply not have enough money to invest after covering their essential expenses.

How much money should be saved vs. invested?

The amount of money that should be invested versus saved depends on one's individual financial goals, risk tolerance , and personal circumstances. A good rule of thumb is to save enough to cover three to six months of living expenses in an emergency fund; a savings account, with enough to cover short-term obligations like bills, and then invest the rest. The specific amount that should be invested versus saved will thus vary depending on factors such as age, income, existing debt, and long-term financial goals.

Why do some people fail at investing?

There are several reasons why people may struggle with investing. One common reason is a lack of knowledge or experience, which can lead to poor investment decisions. Additionally, emotional biases, such as fear or greed , can cause investors to make impulsive or irrational decisions that may result in losses. Successful investing requires a long-term perspective, discipline, and patience - and it can be difficult to stay the course during periods of market volatility.

Saving and investing are both important components of a healthy financial plan. Saving provides a safety net and a way to achieve short-term goals, while investing has the potential for higher long-term returns and can help achieve long-term financial goals. However, investing also comes with the risk of losing money. Each approach has its own pros and cons, and it's important to find the right balance that works for your financial situation and goals. Ultimately, a well-rounded approach that includes both saving and investing can help build wealth, protect against financial shocks, and provide a solid foundation for a more secure financial future.

IRS. " 401(k) Plan Overview ."

• Financial Literacy: What It Is, and Why It Is So Important to Teach Teens 1 of 29
• Financial Goals for Students: How and Why to Set Them 2 of 29
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• Principles of Building Wealth 5 of 29
• Finance Terms for Beginners 6 of 29
• Stock Market for Teens 7 of 29
• Investing for Teens: What They Should Know 8 of 29
• Saving vs. Investing: What Teens Should Know 9 of 29
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• Personal Finance Influencers You Should Know 29 of 29

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Understanding Assignments

What this handout is about.

The first step in any successful college writing venture is reading the assignment. While this sounds like a simple task, it can be a tough one. This handout will help you unravel your assignment and begin to craft an effective response. Much of the following advice will involve translating typical assignment terms and practices into meaningful clues to the type of writing your instructor expects. See our short video for more tips.

Basic beginnings

Regardless of the assignment, department, or instructor, adopting these two habits will serve you well :

• Read the assignment carefully as soon as you receive it. Do not put this task off—reading the assignment at the beginning will save you time, stress, and problems later. An assignment can look pretty straightforward at first, particularly if the instructor has provided lots of information. That does not mean it will not take time and effort to complete; you may even have to learn a new skill to complete the assignment.
• Ask the instructor about anything you do not understand. Do not hesitate to approach your instructor. Instructors would prefer to set you straight before you hand the paper in. That’s also when you will find their feedback most useful.

Assignment formats

Many assignments follow a basic format. Assignments often begin with an overview of the topic, include a central verb or verbs that describe the task, and offer some additional suggestions, questions, or prompts to get you started.

An Overview of Some Kind

The instructor might set the stage with some general discussion of the subject of the assignment, introduce the topic, or remind you of something pertinent that you have discussed in class. For example:

“Throughout history, gerbils have played a key role in politics,” or “In the last few weeks of class, we have focused on the evening wear of the housefly …”

The Task of the Assignment

Pay attention; this part tells you what to do when you write the paper. Look for the key verb or verbs in the sentence. Words like analyze, summarize, or compare direct you to think about your topic in a certain way. Also pay attention to words such as how, what, when, where, and why; these words guide your attention toward specific information. (See the section in this handout titled “Key Terms” for more information.)

“Analyze the effect that gerbils had on the Russian Revolution”, or “Suggest an interpretation of housefly undergarments that differs from Darwin’s.”

Additional Material to Think about

Here you will find some questions to use as springboards as you begin to think about the topic. Instructors usually include these questions as suggestions rather than requirements. Do not feel compelled to answer every question unless the instructor asks you to do so. Pay attention to the order of the questions. Sometimes they suggest the thinking process your instructor imagines you will need to follow to begin thinking about the topic.

“You may wish to consider the differing views held by Communist gerbils vs. Monarchist gerbils, or Can there be such a thing as ‘the housefly garment industry’ or is it just a home-based craft?”

These are the instructor’s comments about writing expectations:

“Be concise”, “Write effectively”, or “Argue furiously.”

Technical Details

These instructions usually indicate format rules or guidelines.

“Your paper must be typed in Palatino font on gray paper and must not exceed 600 pages. It is due on the anniversary of Mao Tse-tung’s death.”

The assignment’s parts may not appear in exactly this order, and each part may be very long or really short. Nonetheless, being aware of this standard pattern can help you understand what your instructor wants you to do.

Interpreting the assignment

Ask yourself a few basic questions as you read and jot down the answers on the assignment sheet:

Why did your instructor ask you to do this particular task?

Who is your audience.

• What kind of evidence do you need to support your ideas?

What kind of writing style is acceptable?

• What are the absolute rules of the paper?

Try to look at the question from the point of view of the instructor. Recognize that your instructor has a reason for giving you this assignment and for giving it to you at a particular point in the semester. In every assignment, the instructor has a challenge for you. This challenge could be anything from demonstrating an ability to think clearly to demonstrating an ability to use the library. See the assignment not as a vague suggestion of what to do but as an opportunity to show that you can handle the course material as directed. Paper assignments give you more than a topic to discuss—they ask you to do something with the topic. Keep reminding yourself of that. Be careful to avoid the other extreme as well: do not read more into the assignment than what is there.

Of course, your instructor has given you an assignment so that he or she will be able to assess your understanding of the course material and give you an appropriate grade. But there is more to it than that. Your instructor has tried to design a learning experience of some kind. Your instructor wants you to think about something in a particular way for a particular reason. If you read the course description at the beginning of your syllabus, review the assigned readings, and consider the assignment itself, you may begin to see the plan, purpose, or approach to the subject matter that your instructor has created for you. If you still aren’t sure of the assignment’s goals, try asking the instructor. For help with this, see our handout on getting feedback .

Given your instructor’s efforts, it helps to answer the question: What is my purpose in completing this assignment? Is it to gather research from a variety of outside sources and present a coherent picture? Is it to take material I have been learning in class and apply it to a new situation? Is it to prove a point one way or another? Key words from the assignment can help you figure this out. Look for key terms in the form of active verbs that tell you what to do.

Key Terms: Finding Those Active Verbs

Here are some common key words and definitions to help you think about assignment terms:

Information words Ask you to demonstrate what you know about the subject, such as who, what, when, where, how, and why.

• define —give the subject’s meaning (according to someone or something). Sometimes you have to give more than one view on the subject’s meaning
• describe —provide details about the subject by answering question words (such as who, what, when, where, how, and why); you might also give details related to the five senses (what you see, hear, feel, taste, and smell)
• explain —give reasons why or examples of how something happened
• illustrate —give descriptive examples of the subject and show how each is connected with the subject
• summarize —briefly list the important ideas you learned about the subject
• trace —outline how something has changed or developed from an earlier time to its current form
• research —gather material from outside sources about the subject, often with the implication or requirement that you will analyze what you have found

Relation words Ask you to demonstrate how things are connected.

• compare —show how two or more things are similar (and, sometimes, different)
• contrast —show how two or more things are dissimilar
• apply—use details that you’ve been given to demonstrate how an idea, theory, or concept works in a particular situation
• cause —show how one event or series of events made something else happen
• relate —show or describe the connections between things

Interpretation words Ask you to defend ideas of your own about the subject. Do not see these words as requesting opinion alone (unless the assignment specifically says so), but as requiring opinion that is supported by concrete evidence. Remember examples, principles, definitions, or concepts from class or research and use them in your interpretation.

• assess —summarize your opinion of the subject and measure it against something
• prove, justify —give reasons or examples to demonstrate how or why something is the truth
• evaluate, respond —state your opinion of the subject as good, bad, or some combination of the two, with examples and reasons
• support —give reasons or evidence for something you believe (be sure to state clearly what it is that you believe)
• synthesize —put two or more things together that have not been put together in class or in your readings before; do not just summarize one and then the other and say that they are similar or different—you must provide a reason for putting them together that runs all the way through the paper
• analyze —determine how individual parts create or relate to the whole, figure out how something works, what it might mean, or why it is important
• argue —take a side and defend it with evidence against the other side

More Clues to Your Purpose As you read the assignment, think about what the teacher does in class:

• What kinds of textbooks or coursepack did your instructor choose for the course—ones that provide background information, explain theories or perspectives, or argue a point of view?
• In lecture, does your instructor ask your opinion, try to prove her point of view, or use keywords that show up again in the assignment?
• What kinds of assignments are typical in this discipline? Social science classes often expect more research. Humanities classes thrive on interpretation and analysis.
• How do the assignments, readings, and lectures work together in the course? Instructors spend time designing courses, sometimes even arguing with their peers about the most effective course materials. Figuring out the overall design to the course will help you understand what each assignment is meant to achieve.

Now, what about your reader? Most undergraduates think of their audience as the instructor. True, your instructor is a good person to keep in mind as you write. But for the purposes of a good paper, think of your audience as someone like your roommate: smart enough to understand a clear, logical argument, but not someone who already knows exactly what is going on in your particular paper. Remember, even if the instructor knows everything there is to know about your paper topic, he or she still has to read your paper and assess your understanding. In other words, teach the material to your reader.

Aiming a paper at your audience happens in two ways: you make decisions about the tone and the level of information you want to convey.

• Tone means the “voice” of your paper. Should you be chatty, formal, or objective? Usually you will find some happy medium—you do not want to alienate your reader by sounding condescending or superior, but you do not want to, um, like, totally wig on the man, you know? Eschew ostentatious erudition: some students think the way to sound academic is to use big words. Be careful—you can sound ridiculous, especially if you use the wrong big words.
• The level of information you use depends on who you think your audience is. If you imagine your audience as your instructor and she already knows everything you have to say, you may find yourself leaving out key information that can cause your argument to be unconvincing and illogical. But you do not have to explain every single word or issue. If you are telling your roommate what happened on your favorite science fiction TV show last night, you do not say, “First a dark-haired white man of average height, wearing a suit and carrying a flashlight, walked into the room. Then a purple alien with fifteen arms and at least three eyes turned around. Then the man smiled slightly. In the background, you could hear a clock ticking. The room was fairly dark and had at least two windows that I saw.” You also do not say, “This guy found some aliens. The end.” Find some balance of useful details that support your main point.

You’ll find a much more detailed discussion of these concepts in our handout on audience .

The Grim Truth

With a few exceptions (including some lab and ethnography reports), you are probably being asked to make an argument. You must convince your audience. It is easy to forget this aim when you are researching and writing; as you become involved in your subject matter, you may become enmeshed in the details and focus on learning or simply telling the information you have found. You need to do more than just repeat what you have read. Your writing should have a point, and you should be able to say it in a sentence. Sometimes instructors call this sentence a “thesis” or a “claim.”

So, if your instructor tells you to write about some aspect of oral hygiene, you do not want to just list: “First, you brush your teeth with a soft brush and some peanut butter. Then, you floss with unwaxed, bologna-flavored string. Finally, gargle with bourbon.” Instead, you could say, “Of all the oral cleaning methods, sandblasting removes the most plaque. Therefore it should be recommended by the American Dental Association.” Or, “From an aesthetic perspective, moldy teeth can be quite charming. However, their joys are short-lived.”

Convincing the reader of your argument is the goal of academic writing. It doesn’t have to say “argument” anywhere in the assignment for you to need one. Look at the assignment and think about what kind of argument you could make about it instead of just seeing it as a checklist of information you have to present. For help with understanding the role of argument in academic writing, see our handout on argument .

What kind of evidence do you need?

There are many kinds of evidence, and what type of evidence will work for your assignment can depend on several factors–the discipline, the parameters of the assignment, and your instructor’s preference. Should you use statistics? Historical examples? Do you need to conduct your own experiment? Can you rely on personal experience? See our handout on evidence for suggestions on how to use evidence appropriately.

Make sure you are clear about this part of the assignment, because your use of evidence will be crucial in writing a successful paper. You are not just learning how to argue; you are learning how to argue with specific types of materials and ideas. Ask your instructor what counts as acceptable evidence. You can also ask a librarian for help. No matter what kind of evidence you use, be sure to cite it correctly—see the UNC Libraries citation tutorial .

You cannot always tell from the assignment just what sort of writing style your instructor expects. The instructor may be really laid back in class but still expect you to sound formal in writing. Or the instructor may be fairly formal in class and ask you to write a reflection paper where you need to use “I” and speak from your own experience.

Try to avoid false associations of a particular field with a style (“art historians like wacky creativity,” or “political scientists are boring and just give facts”) and look instead to the types of readings you have been given in class. No one expects you to write like Plato—just use the readings as a guide for what is standard or preferable to your instructor. When in doubt, ask your instructor about the level of formality she or he expects.

No matter what field you are writing for or what facts you are including, if you do not write so that your reader can understand your main idea, you have wasted your time. So make clarity your main goal. For specific help with style, see our handout on style .

Technical details about the assignment

The technical information you are given in an assignment always seems like the easy part. This section can actually give you lots of little hints about approaching the task. Find out if elements such as page length and citation format (see the UNC Libraries citation tutorial ) are negotiable. Some professors do not have strong preferences as long as you are consistent and fully answer the assignment. Some professors are very specific and will deduct big points for deviations.

Usually, the page length tells you something important: The instructor thinks the size of the paper is appropriate to the assignment’s parameters. In plain English, your instructor is telling you how many pages it should take for you to answer the question as fully as you are expected to. So if an assignment is two pages long, you cannot pad your paper with examples or reword your main idea several times. Hit your one point early, defend it with the clearest example, and finish quickly. If an assignment is ten pages long, you can be more complex in your main points and examples—and if you can only produce five pages for that assignment, you need to see someone for help—as soon as possible.

Tricks that don’t work

Your instructors are not fooled when you:

• spend more time on the cover page than the essay —graphics, cool binders, and cute titles are no replacement for a well-written paper.
• use huge fonts, wide margins, or extra spacing to pad the page length —these tricks are immediately obvious to the eye. Most instructors use the same word processor you do. They know what’s possible. Such tactics are especially damning when the instructor has a stack of 60 papers to grade and yours is the only one that low-flying airplane pilots could read.
• use a paper from another class that covered “sort of similar” material . Again, the instructor has a particular task for you to fulfill in the assignment that usually relates to course material and lectures. Your other paper may not cover this material, and turning in the same paper for more than one course may constitute an Honor Code violation . Ask the instructor—it can’t hurt.
• get all wacky and “creative” before you answer the question . Showing that you are able to think beyond the boundaries of a simple assignment can be good, but you must do what the assignment calls for first. Again, check with your instructor. A humorous tone can be refreshing for someone grading a stack of papers, but it will not get you a good grade if you have not fulfilled the task.

Critical reading of assignments leads to skills in other types of reading and writing. If you get good at figuring out what the real goals of assignments are, you are going to be better at understanding the goals of all of your classes and fields of study.

You may reproduce it for non-commercial use if you use the entire handout and attribute the source: The Writing Center, University of North Carolina at Chapel Hill

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How to Set Financial Goals: 6 Steps

14 Min Read | Dec 29, 2023

Do you feel like you’re trying  so hard  to make the right decisions with your money but never seem to get ahead? Or have you been working your butt off, maybe even picking up a side hustle, but you don’t have much to show for it at the end of the month?

Sure, things like  inflation  and  recessions  are real and can feel like huge road blocks to your financial goals. But even when the economy isn’t going crazy, if you don’t set any goals for your money, you’ll definitely feel like you’re spinning your wheels.

If you want to make progress with your money (for real ), you need to set some financial goals. But don’t freak out. I’m going to help you figure out what your financial goals actually are —and share the steps to reach them. You’ve got this!

What Is a Financial Goal?

A financial goal is any plan you have for your money. You can have short-term financial goals (like saving up $1,000) or long-term financial goals (like buying a house or investing for retirement). It’s a good idea to set  goals for every area of your life , but having specific financial goals means you’re committing to what you want out of life by planning to save and spend money for those things.

But depending on your relationship with money, trying to decide what to do with it can feel as overwhelming as choosing what to watch on Netflix or as exciting as planning a vacation to Disneyland. There are so many options. But you can’t watch all the home makeover shows or ride all the rides at once. You’ve got to pick and choose, and I recommend tackling your goals in an order that’ll set you up for lifelong success. But first, let’s talk about how you can get in the mindset of setting goals.

6 Steps to Setting Financial Goals

Lots of things can influence the way you set your financial goals, including your motivations, values and dreams for the future. And the way your parents handled money and even your own spending and savings habits (which are unique to you) also has a major impact on how you handle money.

Goal planning takes intention and some self-awareness, so carve out time to think about your goals. Find a few minutes to sit down with a cup of coffee or a glass of wine and get ready to dream—big! Once you have a list of goals for your money in mind, you’re ready to break them down into smaller, actionable steps. Here’s how:

1. Make your goal specific.

One reason people don’t hit their money goals is because they’re too vague. You might say, “I want to be better with money.” But what does that actually mean to you? Narrow it down. Or, “I want to upgrade my car someday.” Okay, fun! But what kind of car do you want, and when do you want to buy it?

What if you decided instead to  tackle your debt ? That’s a  specific  area of your money to focus on. Now, let’s talk about how to break this goal down even more.

2. Make your goal measurable.

Okay, so your goal is to pay off debt. Now it’s time to pick an exact amount—what you can measure to know if you hit your goal or not.

While being  completely debt-free  should be your ultimate goal, it’s a good idea to break down that goal into smaller chunks. That way, you have a vision of where you’re going before you get started.

Say you have $30,000 of total debt. You’ll want to start by paying off your smallest debt, like a $15,000 student loan, first. That’s what I mean by setting a measurable goal.

3. Give yourself a deadline.

Here’s the deal: It’s super easy to put off your goals when they aren’t time-sensitive. Stop saying you’ll start someday . You need to give yourself a deadline and make it reasonable—but also a little challenging.

Get a FREE customized plan for your money in 3 minutes! 

Back to the student loan example:  When  do you want to hit your goal? If you want to pay off $15,000 in one year, you’ll need to pay $1,250 each month. Is this possible but also a bit of a stretch? If so, good!

Now, some goals fall into the short- to mid-term category, and these can be tackled in less than five or so. Think of long-term goals as ones you’ll achieve in five years or more. Here are some examples of short- and long-term financial goals:

Short- and mid-term financial goals:

• Saving up an emergency fund
• Saving for a vacation
• Paying for books for an upcoming semester of school
• Buying a new kitchen appliance or renovation
• Saving for an engagement ring
• Putting down a deposit on an apartment lease
• Saving for upcoming medical or dental services
• Buying birthday or Christmas gifts
• Saving a house down-payment

Long-term financial goals:

• Buying a new car with cash
• Paying for your kid’s college in cash
• Saving for retirement
• Launching a business
• Traveling for several months at a time

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4. Make sure they’re your own goals.

When we  compare ourselves to other people , we’re playing a game we’ll never win. So, make sure you’re setting financial goals that make sense for  you . In other words, just because all your friends are taking out second mortgages to renovate their kitchens doesn’t mean you should. Is that one Instagram influencer taking another extravagant vacation? Hey, good for them. But that doesn’t mean you need to do the same thing—or that you’re behind in life if you’re not in the same place. Put the blinders on, focus on your goals, and stay in your lane. And be clear on  why  you’ve chosen the goals you have.

5. Write your goal down.

Did you know you’re more likely to achieve your goals if you write them down? Yep, it’s true—there’s something about putting pen to paper that helps you commit to the task at hand.

So, go ahead and write down your goals. Then, stick them in your car, to your desk, or on your bathroom mirror. Type them in a notes app on your phone, take a screenshot, and set it as your wallpaper so it’s the first thing you see when you pick up your phone. Keeping your goals where you can see them will keep you on track and motivated.

6. Get a goal accountability buddy.

To take your goals one step further, find a goal accountability buddy. This could be your spouse, a close friend or a community—anyone who will cheer you on and check in as you keep working on hitting your goal. Having a cheerleader in your corner and knowing you’re not alone can make a huge difference as you work toward your goals.

5 Examples of Financial Goals

With so much money “advice” floating around, it can be hard to know which financial goals you should aim for first. This is why I have to mention the  Baby Steps when I talk about setting financial goals. The Baby Steps will help you save for emergencies, pay off debt, and build wealth. But there’s a process to follow.

Should you pay off debt first? Save for your kids’ college? Buy a house? Invest for retirement? The 7 Baby Steps cut through all the confusion and give you a clear path to do  all those things . Following the steps will help you focus on one goal at a time so you can make more progress with your money and feel financial peace.

If you have no clue what financial goal to go after first, start by  taking this quick assessment  to find out what Baby Step you’re on.

Here are some more of the most common financial goals people set and tips for making them happen. Are any of these on your list?

1. Create and stick to a budget.

Not only is budgeting one of the top financial goals people set each new year, but it’s also the foundation you should build all your other money goals on.

A  budget  is  how  you make progress with your money. It’s a plan for what’s coming in (your income) and what’s going out (your expenses). You’re telling your money where to go instead of wondering where it went. When you have this plan for your money, you can feel confident you’re taking steps toward your goal every month.

Budgeting helps you gain momentum in  every  area of your finances. If you’re already budgeting, bravo! If not,  get started for free with EveryDollar .

2. Build up an emergency fund.

Life happens. But you   can be prepared for any money problems that come your way if   you’ve got enough money saved up. I’m talking car trouble, medical expenses and busted toilets (you know, some of the most inconvenient parts of being an adult). But when you’ve got an  emergency fund , you can rest well at night knowing you won’t have to go into debt to cover those moments.

Start with the financial goal of having  $1,000 in savings . Then, if you have debt, it’s time to knock that out. (I’ll talk more about that in a minute.) After that, you want to build up a fully funded emergency fund with 3–6 months of expenses. (Again, this is all covered in the  Baby Steps —the proven plan to help you take control of your money.)

When you’ve got an emergency fund, you’re ready for those “life happens” moments. Instead of being worried about what could happen next, you’ll feel confident that you’ve got money set aside to deal with it.

3. Get out of debt.

If you’ve got  debt , it’s time to get serious about paying it off. All of it. Yeah, I know that may seem impossible right now, especially if you’ve got some big numbers staring you in the face—student loans, credit cards, whatever makes up that debt. But here’s the ugly truth: Debt doesn’t move you forward. It   holds you back.  You can’t get ahead with your money if it’s always going to lender payments.

4. Save up for your dream retirement.

Let’s take a second to put on our imagination caps and picture the ideal retirement. Maybe that’s five, 10 or 30 years down the road. Do you want to pack up the grandkids and head to Disney every Christmas? Visit a new state with your spouse once a quarter? Stay home and read every book on your shelves? Take up a fun hobby or travel for international cooking lessons?

No matter what you’re dreaming for the future, you’ll need good retirement investments  now  to make it a reality. After you’re debt-free and have a fully funded emergency fund, I want you to start  investing 15% of your household income for retirement . And guess what? When you have zero debt, all that money you were spending on payments can go straight into your accounts to fund your retirement dreams.

5. Spend less and save more.

Tons of people whip goals out of the air, like “I want to spend less” or “I want to save more,” without thinking about what it means to actually do those things. People, you’ve got to be specific with your goals and intentional about your money habits .

Becoming successful with money is more about changing your behavior than anything else. This can look like creating and sticking to your budget every month, finding deals, using coupons, paying cash, making more money. And here’s a big one: You’ve got to learn how to say  no— even to yourself. I’m not saying never have fun. But if you want to save money, it’s going to take some planning and lifestyle adjusting.

And finally, here’s one of my favorite tips for  spending less  and  saving more : Plan your meals. Food is where most Americans overspend, and meal planning is how you rein that in. Check out my free  Weekly Meal Planner & Grocery Savings Guide  to see how to save time and money on food.

An Example of a Financial Goal in Action

Okay, so now that I’ve gone over the basics of financial goal planning, let me give you an example of how this can work in real life.

A while back, my husband, Winston, and I decided to build a house. Before that, all the extra income we brought in went straight to our general savings. But I knew building a house would cost a lot, and random, unexpected expenses were bound to pop up during the process.

So, we made it a goal to save up as much as we could—specifically toward our house. And while saving up that much money seemed almost impossible, breaking it down into monthly goals gave us so much momentum. Having a plan for our money not only made our dream possible, but it also made the process fun.

Having this goal for our money is also what kept my spending tendencies (aka  spendencies —trust me, it’s a thing) in check. Knowing my money was going toward something I really wanted (way more than any late-night Amazon purchases) motivated me to spend less. And even though there were moments when we felt fatigued—I mean, there were some days when all I wanted to do was relax and spend money—finding creative ways to hit our goal faster kept us on track each month.

Beyond that, it was character building. It’s a time in our marriage that we’ll always look back on and know we accomplished something hard together. It helped cultivate connection between us and  contentment  in my own heart. Now I realize those benefits of the process are worth more than the new house.

Why Is Setting Financial Goals Important?

Having a goal helps you be more future focused with your money. You’ll start to see how every decision you make adds up and makes a difference with your overall  financial health .

For example, if you don’t have financial goals, it’s no big deal to buy breakfast and coffee  every day . But let’s look at just how much that’s really costing you. You’ll typically spend  at least  $25 for just one workweek of lattes—that’s $100 a month! What else could you do with that money?

If you put $100 in an investment account every month for five years, your latte fund could grow into more than $8,000, thanks to the power of compound growth. That’s a whole semester of your kids’ college you’re drinking.

Imagine if you thought even  longer term and invested $100 a month for 15 years. Your latte savings could grow to over $45,000.

And if you invest your savings for 30 years? Your coffee money could grow to over $280,000. A latte a day or a quarter of a million dollars? You guys, I like a good cup of coffee—but not  that  much.

If you want to set yourself up to be  financially secure , find small (or large) sacrifices you can make right now. The everyday things you do with your money today will absolutely affect your future.

Goals Will Get You Where You Want to Be

Financial goals will help you change your mindset, your habits and ultimately your life.

When you’re intentional with every dollar you have, you’re able to make your money go further. That means you get to do more of the stuff you want to do and plan for the things you’ll do in the future.

You can do more than you ever thought possible, but you’ll need financial goals to help you get there. Decide what you want your future to look like and figure out what you need to do  today  to make it happen.

You  can  live on your terms instead of the bank’s.

You  can  get out of debt once and for all.

You  can  build wealth and pay for things that matter to you.

If you’re already planning ahead and dreaming up a vision for the future, check out our 2024 Goal Planner . It’ll help you create and track your goals and stay focused along the journey. Goal setting doesn’t have to be intimidating, and this planner will help keep you heading in the right direction.

And remember, any financial goal you have starts with a budget. This is the foundation. It’s how you get organized and intentional with your money. Go ahead and  start your free budget today with EveryDollar . Then, get moving on those six steps to setting and reaching your financial goals. No matter the time of year, you  can  turn these dreams into reality. Go get it! 

Start Setting Your Financial Goals Today

• If you’re already planning ahead and dreaming up a vision for the future, check out our  Goal Planner . It’ll help you create and track your goals and stay focused along the journey.
• Finally, get moving on those six steps I mentioned to setting and reaching your financial goals.
• Go ahead and start your free budget today with EveryDollar.

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About the author

Rachel Cruze

Rachel Cruze is a #1 New York Times bestselling author, financial expert, and host of The Rachel Cruze Show. Rachel writes and speaks on personal finances, budgeting, investing and money trends. As a co-host of The Ramsey Show, America’s second-largest talk radio show, Rachel reaches millions of weekly listeners with her personal finance advice. She has appeared on Good Morning America and Fox News and has been featured in publications such as Time, Real Simple and Women’s Health magazines. Through her shows, books, syndicated columns and speaking events, Rachel shares fun, practical ways to take control of your money and create a life you love. Learn More.

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It’s easy to set goals. It’s not so easy to make them happen. Christy Wright shares 10 practical tips on how to stay motivated when you feel like quitting.

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AP®︎/College Macroeconomics

Course: ap®︎/college macroeconomics   >   unit 3.

• Fiscal policy to address output gaps
• Calculating change in spending or taxes to close output gaps

Lesson summary: Fiscal policy

• Fiscal policy: foundational concepts
• Fiscal policy

Lesson Summary

Key takeaways, fiscal policy is used to achieve macroeconomic goals, government spending directly affects ad; taxes indirectly affect ad, choosing the correct amount, the balanced budget multiplier always equals 1, lags can complicate fiscal policy in the real world.

• Recognition lag
• Decision lag
• Implementation lag

Key Equations

Closing the output gap, common misperceptions.

• When first learning about stabilization policies, some people think that the objective of stabilization policies is to eliminate the business cycle. But that is not the case. The objective of stabilization policy is not to “fine-tune” the economy. The goal of stabilization isn’t to make the business cycle go away completely, but to make the ups and downs less dramatic. In other words, we don’t want to make the business cycle a flat line, just less “bumpy”.
• Some people mistakenly assume that fiscal policy (or any kind of discretionary policy) is as easy as some simple calculations. Unfortunately, that isn’t very realistic. Lags make active stabilization policy tricky. For one, the self-correction mechanism may be working in the background, so by the time a policy is finally implemented, it might not be the correct action anymore. Another problem is they make it longer before a corrective action kicks in. One potential solution is to have some form of passive, or automatic, stabilizers that will kick in automatically when a problem arises. We learn more about those in the next lesson.
• Some learners confuse two important types of stabilization policy: fiscal policy and monetary policy. Fiscal policy is the domain of governments. Monetary policy is the domain of central banks (which are usually independent of government budgetary actions).
• Another common misperception is that if government spending increases by the same amount as a tax increase, they completely cancel each other out. A $ 100 ‍   million increase in government spending that is paid for by increasing taxes by $ 100 ‍   million won’t completely cancel each other out. The balanced budget multiplier is equal to one, not zero. When there is a balanced budget, the final impact on real GDP is a $ 100 ‍   million increase as a result of the balanced budget multiplier.
• When first learning about discretionary stabilization policies, it can be tricky to remember what specific actions are expansionary and what are contractionary. The table below can be your guide:
• The nation of Xela as an output gap of $ 100 ‍   million. If the marginal propensity to consume (MPC) is 0.80 ‍   , how much would the government need to spend in order to close that gap? How much would taxes need to change to close that gap? I've tried my best. Can I check my work? If the M P C = 0.8 ‍   , then the spending multiplier is: spending multiplier = 1 1 − 0.8 = 1 0.2 = 5 ‍   To find the amount of government spending necessary to close the gap, divide the size of the gap by the spending multiplier: spending needed = size of gap spending multiplier = $ 100  million 5 = $ 20 million ‍   To find the amount of tax cuts needed, first we must calculate the tax multiplier. Since M P C = 0.8 ‍   , and M P S = 1 − M P C ‍   , then we can tell M P S = 0.2 ‍   : tax multiplier = − M P C M P S = − 0.8 0.2 = − 4 ‍   Finally, to find the amount of tax cuts needed, we divide the gap by the tax multiplier: tax cut needed  = $ 100 million − 4 = $ 25 million ‍  
• What are some reasons that a government might want to remove a positive output gap?
• Explain what a decision lag is, and how it impacts the effectiveness of fiscal policy.

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