College
Planning

How to Save for College

There are many ways to save for college. Let’s focus on the big three (529 Plans, Roth IRAs, and investments held inside a brokerage). Why these three? I think they are your best options when you factor in taxes, growth of capital, cost, flexibility, and convenience. You want a plan that is FLEXIBLE. You want low fees. You want to really understand what you are doing. Let’s take a look.

529 Plans

What is a 529 Plan? A 529 is an investment plan specifically designed for a college education.
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  • They are tax-deferred (you do not pay yearly tax).
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  • They are usually tax deductible (the majority of the states offer their residents a tax deduction). There is no federal tax deduction.
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  • They are tax-free when withdrawn(must be educational expenses).
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  • They are flexible. You can always transfer the money to another beneficiary if needed.
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  • You can use a 529 from another state.
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  • Large amounts of money can be contributed ($300,000 in many states).
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  • They have many investment options.
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  • They can offer very low fees (Do it yourself; DO NOT pay a broker to open a 529).
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  • Most 529 plans are inexpensive to start ($25 is the minimum for many).

Now those are a lot of goodies, don’t you think? So, what are the drawbacks?
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  • If your child does not go to college, you will pay a 10% penalty if the money is withdrawn for something other than college.

Roth IRA

The Roth IRA is a retirement account that has morphed into something much more versatile in how it can be used. IF you have a good retirement fund elsewhere (401K, TSP, 457, 403b, SEP, Pension, etc.), you may consider using your Roth IRA as a way to fund your child’s education.
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  • It will be tax-deferred (same as the 529).
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  • It will be tax-free (specifically the principal you have put in).
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  • It is simple (fewer rules).
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  • Many options are available.
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  • It can be cheap (select inexpensive index mutual funds or target date funds at vanguard.com).
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  • They are flexible (If your child does not go to college or gets scholarships, you can keep the money in your account and use it for you).

However, there are some drawbacks:
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  • It’s your retirement account! This means there will be less money for your future retirement needs.
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  • It is also not tax deductible. The money that goes into a Roth IRA, goes in after taxes.
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  • You are limited by how much you can put in.

Taxable Target Retirement Fund(s)

A Target Retirement Fund owns many types of assets, so you don’t have to do it yourself. Let’s say your child is 4 years old, and it is the year 2021. In 14 years (hopefully), that child will be ready for college, so you could choose to place his money in a 2035 fund. These funds gradually become more conservative in their investments as time goes on (less stocks and more bond). Let's look at the pluses.
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  • It is very flexible (you can do just about anything with it).
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  • It can be inexpensive (buy a target date fund that owns index funds at vanguard.com).
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  • There are many options (Vanguard has many target retirement funds that become less risky as the college years approach).
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  • It is simple (you can use the money for anything you want with no penalties at any time).
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  • You can put in as much as you want (no yearly limitations).

However, there are drawbacks.
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  • There is no tax deduction (this is after tax money).
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  • It is not tax-free (you will pay taxes on the interest, capital gains and dividends each year).
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  • You need a little bit of money to get started (the Vanguard target retirement funds require $1,000 to start).

Other College Planning Tips:

So where do we go from here? I would certainly encourage you to investigate all of your options before you invest your money. The Best Way to Save for College, A Complete Guide to 529 Plans, by Joseph Hurley, is a wonderful book that explains these plans all across the U.S.

BIG POINT: If you decide to go with a 529 Plan, DO NOT use a broker! Go directly with the state or Vanguard and avoid any commissions (you can Google your state 529 Plans and find the folks who run the program).

I would start investing immediately whatever option you select. I would contribute each and every month. I would encourage family members and friends to reduce the presents on their birthdays and Christmas, and instead, tell them that money put towards their college fund would be greatly appreciated.

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Stuff the lawyer wants me to say: Investing outside a bank or a credit union is not FDIC insured. You may lose the value in the investments you select. All information provided here is for informational purposes only. It is not an offer to buy or sell any of the securities, insurance products, or other products named. Translated: I am not selling anything! Educate yourself, research the information that you learned and finally make the right decisions that will benefit you and your family going forward.

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