Best Savings Option for Education?

May 4, 2007 11:17 PM

What are the best options for my son's education savings? He's four and so far we've only been able to put about $1000 into savings for him. Would a 529 plan be the best route? What about CDs? I have practically no experience with savings accounts/investment/financial planning, but have decided to start learning about it. Should I go get a Motley Fool book?
posted by bstreep to work & money (10 comments total)

Oh, and what about U.S. Savings Bonds?
Thanks.
posted by bstreep at 11:19 PM on May 4, 2007

A 529 plan would be an excellent option for saving for college expenses. The earnings on the investment accumulate tax free. The trick is to avoid the high cost administrative fees that some mutual funds charge. Fidelity is a very good low cost choice. Fidelity offers simple age-based portfolio funds that start out aggressive in the beginning and automatically gradually become more conservative as the time to college draws closer. For example for your 4-year-old you would choose the Portfolio 2021 fund which is closest to the year when your child would begin college. Vanguard is another excellent choice, but they require a $3000 minimum.

Savings bonds and CDs would have a couple of disadvantages. You would have to pay taxes each year. Also, a fund that includes stocks, like the Fidelity or Vanguard plans, would be expected to have a better return over a long period of time.
posted by JackFlash at 1:09 AM on May 5, 2007

Take a look at the articles in Kiplinger's, such as this one and this one (although they are a bit outdated, the legislation granting tax-free status did become permanent, but they explain nicely how 529s work and what to watch out for in terms of fees). Because in some states you can deduct your contribution to the 529 plan from your state taxes, this may be a more important consideration than which company offers the 529 plan.

And here's Kiplinger's 529 plan finder.
posted by needled at 5:36 AM on May 5, 2007

I am not a (consumer) investment adviser, so you ought to take all of this as merest idling talk, subject to better qualified advice, but:

If your (only?) child is four and you've only been able to save $1,000 for college, that suggests that you might have some more pressing financial requirements that haven't been met, or that a 529 might otherwise be unsuitable for you now at present.

It's important to remember that the 529 is a principally an upper middle class benefit, designed to be used by families with high incomes and/or rich grandparents, who are excluded from most of other forms of government support for education spending. (As an example, its most powerful feature by far is enabling someone to advance up to five years of $11,000 per year gift tax limitation -- i.e., put in $55,000 per donor per child at once.)

Along those lines, there's also no assurance that 529 balances won't lose the relatively benign treatment they now have in the college financial aid process -- if you're of modest income and expect to remain so, you might losing in financial aid a very big chunk of whatever you manage to invest in a 529. (This is not a concern of people who expect to be financial-aid ineligible, based on income, no matter what they've saved.)

In terms of how you can deploy surplus cash before 529 investing, your own debt is obviously the most important issue. If you're carrying any non-deductible debt, you're almost certainly losing money by investing in a 529 rather than paying down a debt. I doubt many planners would disagree with this.

Somewhat more controversially, I would also argue that you (and spouse if applicable) should first be maxing out all tax-advantaged personal savings, too: $4,000 a year into each IRA and maxing out 401ks at work if eligible.

When you've gotten these basics taken care of, however, a 529 starts becoming really appealing, simply because it's the only big pot of tax-exempt savings left to you, subject only to concerns about fee levels and about financial aid impacts if you're in a modest-income-for-life career path.
posted by MattD at 8:56 AM on May 5, 2007 [1 favorite]

I am not your accountant.

If you are saving for university for your child, you should consider how FAFSA calculates the contribution from your child/family for tuition. Basically, until last year a dependent student's assets were levied at 33% (above an asset protection threshold adjusted for age of student and parents). This year that went down to 20%. Parental assets are levied at 5%. A 529 in the student's name is considered a student asset and levied accordingly. Income for both students and parents are levied at a higher rate.

There are two ways around this. One is to put assets in grandparents' names - these do not figure on the FAFSA. The other is to put the student/child's assets into a Roth IRA or Solo 401(k). Retirement assets are not levied by the FAFSA (although some of the more financially aggressive schools want to "look" at these for their financial aid). I would maximize the retirement options first and then look at a 529, but be mindful of the consequences of naming the student as the beneficial owner.

To put money into a retirement account, the child/student oviously has to have income. This can be done, subject to IRS guidelines, and involves some paperwork, but in terms of minimizing the bite from FAFSA is worth it, down the road. FAFSA may change in ~20 years or so, but I doubt it will change in a way that reduces the levy on the student.

This explains how the EFC Formula (basically, the total levy) is calculated. It's quite enlightening.
posted by meehawl at 9:17 AM on May 5, 2007 [1 favorite]

I am a good money manager and very knowledgeable and have my kids' college savings in our state's 529 plan. MattD is right that the tax benefits have an expiration date at this point but many argue that it is unlikely that Congress won't renew it. The website savingforcollege.com has good info about 529 plans and other options. The same guy has written a book, The Best Way to Save for College, which is a comprehensive guide to 529 plans. I found it very useful when I was first reading up on the subject after my first son was born. Among other things, the author addresses issues of tax benefits expiring.

That said, I also want to second what MattD said. A few years ago, a financial planner spoke to a moms' group I was part of, on the topic of college savings. She said the number one mistake parents make when thinking about college savings is to short-change themselves for it. Her argument was that parents should make sure they are taken care of financially before they put money into their kids' education: that means retirement savings, for instance, being in place first, and assigning any college debt, when the time comes, to the student, who has 30+ years of earning power ahead of her, rather than to the parents, who don't.

That doesn't mean setting aside an entire retirement nest egg before saving anything for college. I started by figuring out what my partner and I need to be setting aside for retirement, and that savings gets taken care of first. Right now, we are able to put savings into retirement and into the kids 529 plans. When money is tight, we cut back on the college savings first.

For learning about money management, I can't recommend anything I've read (and I've read a lot!) higher than Jane Bryant Quinn's books. She is a sensible, gimmick-free writer about basic conservative money management. Her large and comprehensive tome Making the Most of Your Money hasn't been updated in awhile but still has good comprehensive information about family financial management. Don't panic at its size--just take it a bit at a time.

Last year's Smart and Simple Financial Strategies for Busy People reflects changes in the financial world since Making the Most was last updated, and is a much quicker read. When I read it last year, I felt like it was the Cliff's Notes version of Making the Most of Your Money--the conclusions without the tens of pages of argument leading to them. It would be a great start for someone just trying to learn.

Also, as a semi-derail: if you're feeling panicked, ever, about college savings (and we do read all those scary articles, don't we, about the hundreds of thousands of dollars it's going to cost us), it can help to think very concretely about what you think your obligation to your kids is. For instance, I'm a very generous mom, but we also live in a town with an excellent community college that has a curriculum track that is designed specifically to feed students into the Big 10 University down the street. I do feel an obligation to help my kids get college educated if they want that, but not necessarily to fund their entire education at a four-year residential college. My savings goal for my kids' college is specifically linked to the tuition rates at Big 10 U (rather than "averages" one might read about). I also assume that they'll start with 2 years at community college and that I'll feed and house them at home while they attend one of the 4 excellent state universities that are within commuting distance of our home. Probably we'll be able to do more for our kids when the time comes, but that's gravy, and in the meantime, I'm comfortable with how the amount I need to save for my specific college plan fits into our family finances now. Your specifics will be different, but I found that it helped me to make a concrete plan based on our specific resources and needs rather than reacting to the general panic about college costs.
posted by not that girl at 9:44 AM on May 5, 2007 [4 favorites]

One important but easily-overlooked bit of information -- whenever possible, keep YOUR name on the investment account and not the child's. 529s had only just come out when I was still a stockbroker, but I believe they do this.

Why is this important? It'll keep you from getting screwed over like I did. My grandmother left me a small sum that multiplied quite nicely over the decade+ between her death and my going off to college.

When the school financial aid officers looked at my parents' combined income (looooow, since my mom doesn't work in the summer and my dad frequently has a lot of time off in the winter), I STILL didn't qualify for aid because I had money in my own name.

Without it, I would've gotten all kinds of aid. It didn't matter that my grandmother's will said I couldn't have it til I was 25. It mattered that it was in my name. So whichever investment path you choose -- I like ING Direct's Orange savings accounts, the interest is quite high -- or put it into some kind of index-tracking mutual fund -- make sure it's in your name.

Something to consider that is easy to do, and will really pile up over time, since you've got a good 14 years: open a Sharebuilder account, put the initial $1000 in and then set up an automated withdrawal/deposit from your bank account. Even if it's only $5 a week, it will add up. Dump the holiday and birthday checks in there, too. You can invest in something like a Spyder (an exchange-traded fund, ticker SPY) and get a diversified bundle of stocks without a lot of fees.

IANLAS (I am no longer a stockbroker), so proceed with caution, but in general, 529s and automatic investment programs of all stripes are both good things.
posted by bitter-girl.com at 9:45 AM on May 5, 2007

Yup, what meehawl said. Should've previewed...
posted by bitter-girl.com at 10:03 AM on May 5, 2007

bitter-girl.com wrote: One important but easily-overlooked bit of information -- whenever possible, keep YOUR name on the investment account and not the child's. 529s had only just come out when I was still a stockbroker, but I believe they do this.

Yes, this is one of the benefits of 529 plans: the account is in the name of the parent (or whoever set it up) with the child as a beneficiary. Also, the money is very portable within the family--unused 529 money can be transfered to another beneficiary who is related.
posted by not that girl at 11:46 AM on May 5, 2007

Thanks everybody for your responses. Lots of good stuff here to think over. I appreciate the time and effort that went into these comments. You've inspired me to start being smarter about my finances.
Thanks again.
posted by bstreep at 7:12 PM on May 6, 2007