Saving for College: Are 529 Plans Worth It?

Worried about funding your kid’s college education? Then let’s start with the good news: There are many ways to pay for college, so you have a lot of options.

But the tricky part is the fact that there are a lot of variables and choices to make in the process. That can make finding the best strategy or choosing the best option out of everything available feel overwhelming.

It’s important to create a realistic plan to achieve your specific college funding goals. Here’s what to keep in mind as you think through this major planning challenge.

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What Percentage of the Bill Do You Want to Foot?

When I talk to clients about this, I start with one big question: What is your expectation?

In other words, do you feel like you should be paying the entire cost of college for your kids? Do you feel like you’re not obligated to pay any of it, and they need to make it on their own?

As with most things, the majority of my clients fall somewhere in the middle. They want to do what they can (and some parents want to do more than what they can reasonably afford — and we’ll get to that in a minute if you’re feeling this way, too).

Which School Makes the Most Sense for Your Student?

The next question I focus on is figuring out what ballpark we’re playing in.

If you feel comfortable footing 50% of the bill for your student, we need to know whether that’s 50% of the bill to an in-state school that might cost $30,000 per year … or 50% of the bill to a school like NYU, which could run $70,000 or more per year.

Obviously, those are two very different things — and there may be even more variables to consider, depending on your family and what your children want to do.

Deciding on the type of school is an important part of this, and you need to get clear on what the purpose of higher education is for your kids.

Are they going for practical purposes? Are they (or you) attracted by the name-brand? What does your student really want to do — and what can they realistically expect to earn as an adult out of school?

If you’re taking out massive amounts of loans when that student has no chance of earning significant income, you’re setting everyone up for failure. And keep in mind that a “famous school” does not directly translate to a “good school.”

With college costs growing so fast, you and your kids need to be intentional about choosing the school for them. You need to look at the tangible benefits of attending the school and graduating with a particular degree … and not just be dazzled by the prestige of certain universities. (To get some ideas of colleges that might be worth the money, see Kiplinger’s Best College Values, 2018.)

If you think it’s ridiculous to buy a high-end sports car just to show off to everyone else, keep in mind that going to a school just for its name can be just another form of status symbol.

The Specific Variables to Consider (and Adjust) When Saving for College

When it comes to actually figuring how much to save for college, how to do it, and where to put that cash between now and when your kids go to school, you must know the details of a number of variables to create a plan:

• Annual cost of college
• Expected inflation rate of college tuition
• The year college starts
• Balance of current savings
• Amount of additional monthly contributions
• Targeted rate of return on money saved

A financial planner can help you run projections that use these variables to come up with a very specific amount of money you need to save per year or per month in order to meet your college savings goals.

Getting the answer to “how much should I be saving for college?” is helpful and can give you peace of mind… but most people aren’t saving for college in a vacuum. In real life, we have competing priorities — which is another reason to work with a financial planner on this issue. Their perspective can help you figure out how to deal with all these competing priorities, the biggest of which might be your own retirement.

A Warning: Saving for College vs. Your Own Retirement

The biggest mistake I see my own clients make is their desire to do everything they can to give their kids a full ride to the university of their choice — regardless of the cost and the reality that they have more than just that college savings goal to fund.

I can’t stress this enough: DO NOT bankrupt your retirement savings to pay for college. DO NOT sacrifice your own financial security for the sake of paying for college for your kids.

Why? Aren’t your kids the most important thing in a parent’s life? You could argue that, but I’d like to remind you there are lots of ways to fund college. You can pay for tuition and other college costs with:

• Savings or ongoing cash flow
• Loans (within reason)
• Scholarships and grants
• Other financial aid

Your family also has control over a number of variables in the situation, including your student’s ability to attend a cheaper school, stay in-state versus out, choose public instead of private, or work part-time to help cover their expenses.

You have options for college funding. There is only one way to fund your future retirement, and that’s you and your ability to save and invest for it today. There is no Plan B, so you must prioritize funding your own life after work. If you’re not on track with your own savings, you need to focus there first and figure out if and when you can help out with college later.

Saving for College with a 529 Plan: Does It Make Sense to Stash Cash Here?

Once you determine how much you feel comfortable and able to put toward a child’s college education, the next question is where do you put that money?

If you’re starting when your kids are young, you may have 10 or more years between now and when you need to use the funds — and that means you should consider investing that cash instead of letting it sit in a savings account earning little to no interest.

With a time horizon that could stretch over a decade or more, investing can help you take advantage of compounding returns and put your money to work (so you don’t have to save the entire cost of college, dollar for dollar, on your own).

Many people saving for college choose 529 plans as their investment vehicles, and that’s for good reason. 529 plans offer tax advantages that can help you allocate even more dollars to education expenses.

There are a variety of plans available, and you’re not limited to just your own state’s plan. You may want to consider it if you get a deduction for using your in-state plan; if you don’t or the deduction is minimal, you might want to use another state’s plan if it offers lower fees and better-quality investment options.

For example, I live in Massachusetts — but the maximum deduction I receive for using Mass’ 529 plan is $102 per year. That’s such a (relatively) small deduction that I’m probably better off using another state’s plan (and in fact, I often recommend New York’s plans to my Massachusetts clients).

SavingForCollege.com is a great place to research different programs if you’re not sure where to start.

The Downsides of the 529 Plan

Before you start stuffing cash into a 529 plan, know that it might be wise to only invest money that you know will go toward qualified education expenses.

Again, there are tax benefits to using 529s. If you invest $10,000 and it grows to $20,000, for example, that growth is tax-free, so you don’t pay dividends or capital gains taxes like you would on growth in a regular brokerage account.

But if you don’t use the money for qualified education expenses, then you will pay a 10% penalty on the growth as well as taxes on that amount. (There is an exception to this: If your child gets a full scholarship, the 10% penalty is waived.)

You could also transfer the account from one beneficiary to another within your immediate family (or even use it for your own education); there’s no penalty for that. If you have two children who don’t overlap years in college, you might just want to fund one account and change the beneficiary on the account to the younger child when the older student finishes school.

Should You Use a 529 Plan or a Plain Old Brokerage Account?

If one of your priorities is flexibility because you don’t know how much you want to contribute to a college education or how much it’s going to cost or if your kids will stay in school at all, a non-retirement investment account (or brokerage account) might be better for you.

You can then use that money for whatever you want; it’s still invested and hopefully earning a reasonable return. There are no penalties for using it for non-education costs if that’s what ends up happening. The only downside here is the fact that there’s no specific tax advantage.

At the end of the day, if saving for college is important in any way shape or form, know that actually saving the money is the most important thing. It doesn’t really matter what vehicle is the best one for your savings if you’re not saving anyway!

That being said, I still think it’s a good idea for parents to open 529 plans for their kids even if they don’t want to put their own money into the accounts. Why? Because it makes it easier for other people to help you save for the cost of college.

Even if you’re not sure how you will fund it (if at all), open a 529 plan so that grandparents, aunts and uncles, other family members or family friends can contribute to it.

The only thing I would suggest not doing is fully funding a 529 plan with the amount you think you need to pay for college. Again, if you overfund it and cash out the excess money for non-education purposes, then you’ll be penalized for your savings.