Why 529 Plans May Not Be Best Place for College Savings

November 1, 2011

President Obama’s announced plans to use executive orders to change student loan payback and loan forgiveness continues a trend of increasing government support for college debtors (not savers). It’s important for young professionals that are considering how they will pay for a child’s education in the future to consider this trend, and that it may make sense to maintain flexibility in their plans because of it.

 

When young savers seek financial advice it is often when they begin to feel faced with the decision of where to begin to save for a newborn’s college education, while continuing to advance their retirement plan.

 

The most frequent tool they use is a Section 529 plan which allows for tax-deferred growth and tax-free withdrawals for qualified education expenses.

 

I’m often hesitant though to advise parents to fully fund a 529 plan. Below are a few reasons why:  

 

529 plans have the most limited purpose of any tax-advantaged plan. There are advantages to using retirement accounts for college savings, but none for using college savings accounts for purposes other than college.

 

529 plans have the most limited control over the underlying investments. Just like an employer’s retirement plan, the saver has limited control over the investments. In retirement savings, there are often other options such as saving to an IRA instead of continuing to max a 401(k). Not so with the 529; it’s the plans options or nothing at all.

 

The investments are risky. More often than not, the investment plans take on more risk than is recommended. As opposed to retirement, the payout period for college savings is relatively short, and there is little time to recover from taking too much risk. Combine that with the fact that investment losses hurt more when its savings meant for a loved one, and I don’t think these plans understand the amount of risk they subject investors to. 

 

Saving for college eliminates college financing options. Having a fully funded college savings plan assumes there will be no scholarships, government subsidized loans at below market interest rates, scholarships, or loan forgiveness. Those who want to do the right thing, and put off their own retirement savings in order to fully fund education accounts are the ones that are punished when the government helps non-savers with college.

 

I recommend using 529s, but not as the only means to finance college. If you haven’t maximized your options for retirement savings, consider doing so before a 529 plan. These funds are often available to use for college either without early withdrawal penalty or via a loan. Also, think about your future ability to pay some of the bill with cash flow, tax credits, gifts, or gifts from others. Consider investing, but keeping control of the investments by doing so in a tax-efficient mutual funds or I-Bonds, whose interest can be deferred and not recognized if used for college.

 

With costs rising above inflation and competition increasing to get the big name college experience, your child’s college plan is very likely to be different than yours. This may mean less expensive as they turn to private and community colleges for more credits. Depending on the political climate of the day, the idea of subsidizing tuition and forgiving debt may carry even more weight than it does now.

 

Or, your beneficiary may not attend traditional college at all and your well intentioned plan to cover the costs may have been a gift to Wall Street, rather than a useful part of your plan. 

 

The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes. http://www.forbes.com/sites/feeonlyplanner/

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