A recent article in Kiplinger.com urges parents to “keep on saving” to fund college education for their child (or children). In particular, the piece vigorously encourages the use of 529 saving accounts (see link to the article below).
While we are certainly proponents of saving for college, we also stress that saving for college does not equal planning for college. Saving plans are but one element in the college search and admissions campaign.
While technically correct, this article makes some broad assumptions.
Many parents are ten years or less away from college bills with only a few thousand dollars in savings, and I think it’s safe to assume just about all of these folks would like to be sitting on enough cash to make a dent in college expenses.
Saving for college, however, is but a small part of planning for college, and for many families, setting up a 529 savings account may not be the best strategy in the long run.
The author fails to account for several key issues facing families who find themselves in this situation.
Many questions pose themselves before parents rush into a 529 savings account. These are some of the more crucial issues:
- How much do they have saved in qualified retirement plans right now, and how much are they contributing annually?
- What are the tradeoffs between saving for college in a 529 plan versus saving as much as possible for retirement – especially with regards to potential eligibility for need-based financial aid?
- Will it be possible for these parents to fund college and still be on track for a reasonable retirement?
Here are my thoughts on each…
Current retirement plans:
If parents have not been saving consistently for retirement, saving for college is not their
major concern. I’m of the opinion that the majority of financial planners would recommend that they take a hard look at where the money goes and tighten their belts to allow for putting money aside for their future.
By creating additional cash flow to fund retirement for ten years, they don’t lose the time value on their investments. When it comes time for college, the cash flow could be diverted to paying for college directly from income, or a combination of income and parent loans.
In any case, the discipline of saving allows them to solve two problems with one solution.
Trade Offs:
Yes, the tax advantaged 529 is a plus, but it’s after tax money that funds those plans.
Putting the cash flow into retirement plans has major income tax advantages in addition
to the future value of the investments. Even more potentially harmful, is the impact the
529 accounts could have on potential financial aid eligibility.
For example, money set aside in retirement plans is 100% exempt from the aid formulas, while money in 529 plans could be assessed as much as 5.65%.
In other words, if a family saved $20,000 in a 529, it would cost them about $1,130 in potential financial aid in addition to an additional $3,000 in federal income tax (assuming the 15% bracket) and even more in state income tax.
Funding college and retirement:
No doubt, this is perhaps the largest hurdle most middle to upper-middle income families will face.
The solution lies in getting sound financial advice from a financial planner or personal financial specialist who understands how to strategize for both the college financial aid formulas AND the appropriate retirement savings strategies.
And, I would be remiss without mentioning www.savingforcollege.com – the most informative site on 529 savings plans available.”
We nevertheless recommend reading the original article and the good points it raises, “College: Keep On Saving” by Jane Bennett Clark, Senior Associate Editor, from Kiplinger’s Personal Finance magazine, October 2009.
But remember the old adage:
“Look before you leap!”
