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There's more to college savings than just a 529

By
Erin Lowry
December 28, 2017
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Parents want to be able to give their children everything. Then they hear about the cost of college.

Data from The College Board found it cost parents $56,840, on average, in the 2016-2017 school year, to send their child to an in-state school for four years. It’s nearly double for those attending private universities. So, it makes sense why some parents start saving for college while the baby is in utero!

Common savings options are the The 529 plans. These plans provide parents with an option to invest their college savings nest egg tax-free, as long as the funds are used on qualified education expenses. 529 plans come in two forms: prepaid tuition plan (if available in your state) or a savings plan. There are, however, a few downsides to these options:

Contributions to the 529 Plans are not tax deductible.

Limited investment options, which are generally mutual funds.

Your child would have to attend state school in your state to maximize the prepaid tuition plans, which limits flexibility.  

Should your child elect to forgo college, vocational school, or any higher learning, and there isn’t a sibling on whom the savings could be used, then you’ll have to pay federal taxes + a 10% penalty on any amount you withdrawal for non-qualifying education expenses. 

Luckily, there are options which provide more flexibility when it comes to saving for your child’s college education.

Raiding the roth IRA

You can make withdrawals on Roth IRA contributions (not earnings) because they’re post-tax, which means you avoid triggering a tax penalty for taking a withdrawal before reaching 59½. You can also take withdrawals for qualifying education expenses without triggering a tax penalty. Retirement accounts, including IRAs, are excluded from FAFSA form calculations, which could make saving in a Roth IRA a strategic move should you want to maximize your child’s financial aid options.

The downside: you can only contribute up to $5,500 annually if you’re under 50 and $6,500 if you’re over. High income earners also get phased out of contributing to Roth IRAs. You could also be harming your future self if you aren’t careful. Any parent interested in leveraging a retirement vehicle for college savings needs to be doing it in addition to saving for retirement in other ways.

Earmarking a brokerage account for college

Instead of locking up money in a retirement or college-savings specific vehicle, you can always set up a taxable brokerage account that you mentally earmark for college savings. This gives you plenty of flexibility when it comes to both the types of investments and how the money can be spent. The risk of course is a down turn in the market close to when you need to start making withdrawals to pay for college tuition. Also, your capital gains when you liquidate to pay for college will impact FAFSA forms and your child’s financial aid options.

Municipal bonds

Municipal bonds don’t offer the same growth potential as stocks, but the risk is lower and they are federally tax-exempt on interest. Like brokerage accounts, bonds also aren’t exclusively locked up for qualifying education purchases.Unfortunately, the realized capital gains on selling will impact a child’s FAFSA form, just like with brokerage accounts.

Plain old savings account

This option is not the most lucrative and isn’t the best choice for long-term savings given low interest rates compared to inflation. But, it could make sense if your child is close to 18 and you’d prefer not to take on too much risk in the stock market. Be sure to search for the highest possible interest rate and not one at 0.01% or consider a certificate of deposit to maximize your return.

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