This year, I was slightly shocked when I realized my oldest child would be graduating from high school in just seven short years. Granted, seven years is still quite a long time, but any parent will nod their head in agreement when it’s stated how incredibly fast the years go by when raising children (even though the days may seem long at times!). In a blink of an eye, my son will be faced with the decision on what his next step is after high school. Some form of post-secondary education will certainly be an option and likely expected. With that comes the costs of paying for college, which continue to climb higher year after year even when compared to inflation.
Did you know?
The average college tuition and fees have increased by 1200% since 1980, while inflation is up 236% - Courtesy U.S. Bureau of Labor Statistics
The main question that often arises when saving for college is discussed is “What options are available?” and “What should I use?”. And while everyone’s situation is unique; in my work, I’ve found there are two popular options available. I utilize both for my children.
1) The 529 plan
The 529 plan is the current king when it comes to options for saving for college and for good reason. So long as the funds are used for educational purposes, all the money in a 529 can be withdrawn free of taxes. For example, if I contribute $50/month to my child’s 529 plan until age 18 and earn 8% per year on average, I will have approximately $24,000 saved up in the 529 account even though I only contributed $10,800. That $24,000 can all be withdrawn free of taxes so long as it’s used to pay for my child’s education.
The other benefits of the 529 plan are dependent on the plan you choose. I live in the state of Iowa and I’m fortunate that the state offers an exceptional plan that has a good selection of investment options at low fees. I also receive a modest tax deduction based on how much I contribute to a 529 plan. Most states offer a 529 plan that should have similar benefits.
The one drawback of a 529 plan is the question of what happens to the funds if my child doesn’t go to college or doesn’t need the money for college. Unfortunately, if the funds are withdrawn for a purpose other than an educational expense, there is a 10% penalty plus taxes on the gains in the account. There is however an option to change beneficiaries on the account. For example, if my oldest child doesn’t need any money for college, I can change the beneficiary to his sister, and she could use the money instead. You can change the beneficiary to any family member or even yourself if you were inclined to go back to school.
2) Custodial account
The other popular option for saving for your child’s college education is a custodial account. The benefit of a custodial account is the money can be used for anything and you have the freedom to invest the money into whatever you choose.
The drawback to the custodial account is there are no tax benefits to the account. You will pay capital gains taxes on whatever gains you realize in the account and there is no deduction for contributions.
As I mentioned earlier, I use both for my children, though I do lean more towards a 529 than a custodial account. I do this because I want to have options on where we can withdraw funds. The 529 will be used to pay for tuition, room and board, books, etc. While the Custodial account can be used to perhaps buy a car or just help with regular living expenses in college.
A good place to start if you have any questions is to reach out to a Certified Financial Planner™ who can help determine the right options for you.