Over Memorial Day weekend my company was an exhibitor at the San Francisco Birth & Baby Fair.  As usual, many expectant and new parents wondered by my table, and when I asked them about their financial plan, they hesitated, “Well, we’re going to get a 529 Plan....right??”   

Not so fast, I caution you.  College funding is often detrimentally the primary focus of new parents’ financial plans.  With the birth of a child, parents suddenly feel a need to start saving for college.  Before their child can eat solids --- let alone order out a late night pizza ---parents feel the stress of the tuition bill.  This is not surprising.  The cost of college is increasing at a rate that is almost double inflation, and it does not appear to be changing any time soon.  If you have had a baby recently, you are looking at shelling out approximately $250,000-$450,000 (depending on cost and investment assumptions) if you decide you want to pay for your sweet baby’s college.  This means you have to save $500-$1000 a month for 18 years (more or less, again depending on assumptions) to fund a college education fully.  Yikes!     

You may think it is almost blasphemous to say that parents should not save for college yet. I shock many parents when I don’t jump in and quickly answer their question, “Should we get a 529 Plan?” They may expect that I start listing the states’ plans which I would select, but I truly do not know how to answer that question.  It’s like my son’s favorite Animal Rescuer.  Once his trusty camera locates the crying wolf pup, she has to “zoom out” to see more of the picture. That is what I have to do before I can answer the inevitable 529 question.   

What is your Big Picture?  How is your retirement savings?  Are you on target to have enough saved for your later years (probably not---that’ll be a different article)?  Have you switched from two incomes to one?  Do you plan to move into a more expensive home soon?  What are your values? What are your priorities?  And the list goes on.... 

Let’s say you’ve met with your financial planner and/or you’ve had a focused exploration of all areas of your financial situation in another manner.  You’ve decided you do have college savings as a top priority, and you are ready to contribute some cash.  Should you have a 529 Plan?   

The answer is a very clear “maybe.” 

While there are many vehicles for college savings, I will focus on the common dilemma I address with most parents, “Should we fund a 529 Plan or just put our savings in a tax deductible account (a regular brokerage account)?”   

If you are not familiar, a 529 Plan is a college savings account into which you make after-tax contributions and invest in funds as offered from your selected state’s plan.  As long as you use the funds in the account for qualified education expenses (tuition, room, board, etc.) for the named beneficiary, you will not have to pay tax on the investment gains.  This tax advantage makes these accounts very exciting!  

However, 529 Plans may have limited investment choices, narrowing your options and potentially limiting your ability for maximum gain or adequate diversity.  Finally, non-qualified distributions will be taxed at ordinary income tax rates and assessed a 10% penalty, so if you do not use the money for education and you do not transfer it to someone else, you pay the price.   

You do not have to take advantage of any of the college savings vehicles to pay for college----or use them exclusively.  Many people choose to invest in a regular brokerage account, paying capital gains (15% in many cases) on the sale of assets when it is time to pay for college. This route opens up the potential use of the funds (rather than limiting it to education and the rules of the education accounts) and gives ultimate flexibility in investment choices.   

How do you decide which vehicle to choose? Take a look at your situation and your habits: 

1. Check in on your total financial picture, especially your retirement goals.  Do you know how much money you will need when you retire (it’s a higher number than you think!)?  Are you on track?  Most couples I meet with get my “oxygen mask” speech, “Secure your mask before putting on your child’s.....”  In other words, save first for your retirement, then focus on education, especially if dollars are limited.  You can borrow for college, but not for your retirement. And who would have to step in to care for you if you run out of money?  Your children. 

 

As you look at where to put your investment dollars, remember that IRAs have special rules for using funds for education expenses, and taxable investment accounts can be used for retirement or education.  The tax argument for using a 529 may be a moot point when you finally want to use that money ---- it depends on the investments available, the rates of return, fees charged, capital gains tax rates, and cost of borrowing if you need other funds to name a few factors.   If you want to leave your options open for use of your savings, then a 529 Plan probably does not work best for you.   

2. Do you have parents/grandparents who want to contribute money for your son’s or daughter’s education?  Do they care what kind of account the money goes to?  Often times, grandparents like to be assured that their money will go to pay for college and not your next vacation.  This is where a 529 Plan comes in handy.  529 Plans give family members the comfort of knowing their contributions are earmarked for education.  Plus, you may encourage ongoing giving by having an account in place into which anyone can contribute. 

 

3. What are your savings habits?  Would you be too tempted by an accessible brokerage account?  Will having a specific education account for which you’d be penalized if you withdraw money for other uses be the most assured way you will save for children’s college?  Do you just like the idea of having money set aside in an account specifically labeled for college?  If yes, then a 529 Plan could work well for you since it would separate these savings from other funds.   

 

When it comes to college savings, you will probably want to utilize a few different vehicles.  Which one(s) are best for your situation --- and whether or not you should even save for college right now--- should only be answered after looking at your total financial picture.  Before you jump right into making a large contribution to a 529 Plan, make sure you “zoom out” to see more of the picture first.