Will a 529 Savings Be Enough for College? Here’s What Else You Can Do
As the parent of a young child, I constantly worry: I worry about what she eats — or does not eat, which is anything with nutrients — how long she sleeps and that she might get hurt. But one of my biggest worries is that I won’t be able to save enough money for her future while also saving for my own.
Many experts recommend saving for retirement over saving for college, as writer Ruth Davis Konigsberg from Time Money explains. While it’s easy, though not ideal, for you or your child to take out loans to pay for college, there are no realistic or recommended loan options to help you through retirement. Ideally, you should save for retirement and your children’s college education simultaneously.
The best-known way to save for college is through a 529 plan. Similar to your 401(k), a 529 plan is an investment account that’s exempt from federal income tax, helping you save more money for your child’s future.
My husband and I opened a 529 plan for our daughter soon after she was born. It’ll be years before she needs to use it, but given the rising cost of college education, I want to save as much as possible while I can.
I often wonder, though, what else I can do to save for my daughter’s future, as well as any future children I might have. While a 529 seems to be the ideal option, there must be other savings methods I can use to supplement her college fund. Rather than wondering and procrastinating, I decided to find out for myself.
Consider the Future
It’s impossible to see into the future, but if your child is older, you likely have a better idea of what their future might look like. William Baldwin, contributor to Forbes, uses the example of a 10-year-old girl who could either go to a private school or a cheaper state school.
In the former scenario, you likely want to throw as much money as possible into your 529 plan to help pay for that expensive education. But in the latter option, you might want to stop adding to the plan once you hit a certain figure, such as $100,000.
The reason that you don’t want to save more in a 529 plan than you think your child will need is because you’ll be hit with penalties if you try to spend the money on anything but education-related expenses. That means you’ll have to pay taxes on that money and a 10% penalty.
So, if your child goes to a state school, you might only spend half of what you’ve saved for on tuition. You’ll then take a hit on that additional money when you withdraw to pad your retirement account or nest egg.
Additionally, the more you save in a 529 plan, the bigger impact it’ll have on your child’s ability to qualify for financial aid. Savingforcollege.com points out that the impact is limited, though it is real. Generally, if the parent’s assets, including the 529 money, total $20,000 or less, then the expected family contribution calculation won’t take it into account.
The EFC calculation will count a maximum of 5.64% of parental assets over $20K. The bottom line is this: The more you as the parent have in assets, the less money your child will receive from financial aid.
Additional Ways to Save
Prefer not to use a 529 account or want to supplement it with additional savings? Here are a few other options to save for your child’s education.
You probably remember savings bonds as something boring your grandparents gave you for your birthday.
But savings bonds can be a great way to save additional money for your child’s future. Ian Salisbury of Time Money explains that “Interest earned on Series I and EE savings bonds is exempt from federal income tax when used to pay for higher education.”
But what does that mean, exactly? Series I savings bonds are low-risk and earn interest during the time you own them. The interest rate on a Series I bond is currently 2.58%, according to Treasury Direct. That’s more than you’d get from a basic savings account but not the return you’d see in a 529 plan.
The rate is determined by two factors: the fixed rate of return determined when you buy the bond and a biannually calculated inflation rate.
Series EE bonds have a lower interest rate of 0.1%. They earn a fixed rate of return based on the date of purchase.
Savings bonds might have a lower return on investment than 529 plans, but they are generally less risky than putting all your money in an investment account.
Another savings option for your child’s future is a custodial account. According to Dan Caplinger and Gaby Lapera of The Motley Fool, this is an investment account you open on your child’s behalf. Unlike a 529 plan, a custodial account doesn’t come with tax benefits, but if the account remains below a certain threshold, then it’s taxable at the child’s rate rather than the parent’s.
The threshold is subject to change each year, but Charles Schwab reports that the first $1,050 is untaxed and the next $1,050 is taxed at the child’s rate for minors under 18. After that, the IRS will tax the money at the parent’s rate.
The main benefit of a custodial account is you can invest your money wherever you like. In contrast, a 529 account tends to dictate your options, which can be limiting. If you’re familiar with the world of investing or have a trusted financial advisor, a custodial account might be a good option. Like all investments, your success here may vary with the amount you invest and what you invest in.
Custodial accounts share one drawback with 529 plans. The money saved in one of these accounts is considered the child’s money when taken into account for financial aid. The more money in the custodial account, the bigger hit your child will take on financial aid.
Additionally, custodial accounts must be turned over to the child on their 18th birthday. If you want your child to go to college, but they have other ideas, they are within their rights to spend it on anything they want — and what they want at age 18 might not be a college education. Unlike a 529 plan, there are no penalties for spending this money on anything other than education.
If you are able, a 529 plan is still the best bet when it comes to saving for your child’s college education. But if you have the means to save a little more or want to save in a variety of ways, savings bonds and custodial accounts are good ways to spread your savings around.
Catherine Hiles is a full-time editor living in Ohio with her husband, their daughter and a cranky old dog. She enjoys running, eating, beer and puns.