Some would call my oldest son an academic overachiever. He’s dead set that he’s never getting anything but A’s on his report card — through the rest of middle school and high school. Oh, and apparently my wife and I can stop saving for his college because he’s going to get an academic scholarship. Of course, I’m learning that teenagers have a tendency to shift their focus from time to time so I think I’ll keep saving ... just in case.
The reality is, saving for college is a topic that comes up quite a bit in my line of work. Specifically, I’m often asked whether 529 college savings plans are the best way to stockpile money for the intimidating expense of college. As a financial planner by trade and an owner of a couple of 529 plans by choice, here are my thoughts on the subject.
The Right Answer? Just Save
I'll start by saying that the most important — and often most difficult — decision regarding any college savings plan has nothing to do with which program you’ll use; it’s actually doing the saving. That said, if the sole purpose of your efforts is to pay for college, I’m a big fan of 529 college savings plans.
While not an exhaustive list, here are some key advantages of 529 plans:
No income tax bills – Any growth in these plans is tax-deferred, and if withdrawals are used for qualified college expenses, they are tax-free. Given the price tag of a college education, no taxes could save you a bundle.
Minimal management needed – To make investing easier, most 529 plans offer a range of prepackaged investment alternatives that include both static allocation plans and age-based plans. Static allocation plans are a mix of investments that are regularly rebalanced to keep a certain blend of asset classes. Age-based plans are a mix of investments that start off more aggressive when the child is younger and get more conservative as college admission time draws near. The account owner only needs to select the approach; the plan managers take care of the rest.You stay in control – Unlike some savings strategies for children, 529 plan assets typically never become the property of the child. For the control freaks like me out there, this is a nice feature. It means you can change beneficiaries or even withdraw the money and use it for other purposes. Just know that if the money doesn’t go toward college expenses, you’ll likely face taxes and penalties on any earnings that are withdrawn. This makes doing so inadvisable, but it’s an option if you really needed it.
In keeping with the spirit of nonexhaustive lists, here are a couple of potential drawbacks of 529 plans:
College expenses only – Unless you’re interested in paying taxes and penalties to the IRS, you won’t be using these dollars for anything except qualified college expenses. This means no using it for private elementary or high schools, and money for cars, computers in high school or even the senior class trip must come from elsewhere. The money has to be used for college. Use it to pay for anything else and it could cost you.
Fewer investment choices – I mentioned earlier that most 529 college savings plans come with a list of prepackaged investment selections. While that’s a great benefit for many folks, those who like to have more control over their investment choices may see it as a drawback. The investment choices that come with the plan are typically all you get.
What’s the Best Approach?
As I mentioned earlier, the best approach to college saving is to actually do it. While the choice of college savings programs is something to be considered carefully, there is no one best solution for all situations. For my family, the positives of 529 college savings plans outweigh the negatives. Oh, and by the way, if my son does end up getting that scholarship (he's a pretty smart kid), I can always transfer his account to his younger brother or pull out the amount of the scholarship penalty-free (but not tax-free).