Ever since my son was born three years ago, I have been putting checks from Grandparents and other family members into a regular old savings account.
Each check was relatively small but they started adding up fast.
Each time I deposited a check I would think to myself, “You should be doing something else with this money. You should get it invested.”
But, like things do, it sat on the back burner for a while until I came across this statistic (numbers based on WA State):
The average cost of a 4-year public school today is $75,000. If you have small children you can expect that number to balloon to $150,000 by the time they are heading to college.
Woah!! That lit a fire under me.
But before I continue… a disclaimer:
I believe that parents should not be saving or paying for their kids’ college at the expense of their own financial future. Of course, we want to give our kids a head start in life but the biggest gift we can give them is the peace of mind knowing we will be taken care of in retirement. Plus, there are scholarships, financial aid, and other creative solutions to help make college work if you can’t make college savings a priority right now. [steps off soap box]
That said, it made sense for us to invest this money for our son’s future education. As I researched all the available options and weighed the pro’s and con’s I realized that there was no slam-dunk solution for our needs. Plus, it got confusing fast!
So today, I want to share my research with you to help you decide what the best savings choice would be for your family. If the “financial speak” below feels overwhelming or you need help deciding what is the right choice for your family, I recommend consulting a fee-based fiduciary Financial Advisor.
Ok, here we go!
The best options for saving for college can be narrowed down to the 529 College Savings Plans and a Roth IRA.
529 College Savings Plan
This is the most recognized name in college savings plans. Each state has a different version of a 529 Plan that might have a slightly different name. For example, in WA state the plan is called the GET plan, but it’s essentially a 529 plan.
529 plans allow you to purchase college credits for the future at today’s cost. Awesome right!? Well, there is a downside. If your child ends up not wanting to go to college, getting a scholarship, or otherwise not needing the money there are pretty big penalties to cash out your account.
Pro’s
* Tax-free investment and tax-free withdrawals
* Buying college tuition at today’s rates
* No income limitations on participation
* Contribution limitations $14,000 per year
* Tuition credits can be used at any school that accepts financial aid (virtually all the public and private schools in the country)
Con’s
* Any money you don’t use for education is fully taxable as ordinary income and has a 10% fee (e.g. A $100K account would get hit with a $10K fee and $20K in taxes (assuming a 20% tax rate) upon cash out. Ouch. Other options to avoid the penalties include letting the money sit for graduate school or transferring the money to be used for school by another family member.
* Generally, can’t be used for schools outside of the USA.
Roth IRA
One alternative to the 529 Savings Plan is a Roth IRA. The Roth IRA has to be opened in a parent’s name but earmarked for the child until they turn 18. You save money in a Roth IRA like any other retirement account you might have. When it comes time for college, Roth IRA rules allow you withdraw the principle of your investment (the contributions, not the earnings) for “qualified educational expenses” which includes tuition, room, board, etc. Any leftover money (haha, I know) would be left in the account for the parent’s retirement.
Pro’s
* Tax deduction on contributions
* Can withdraw for “qualified education expenses” (tuition, fees, room, board)
* Any leftover or unused money is not penalized and can be used for other purposes
Con’s
* If you are taking withdrawals before you hit age 59, you can only withdraw the principle of your investment tax-free, not the earnings
* Can only contribute $5,500 per year (lower than the 529 plan)
* Ability to participate in a Roth IRA phases out at a gross income level of $188,000 for married couples
* Not able to purchase tuition credits at today’s cost
Our decision: We are going to start with the 529 Plan
Although I hate the idea of the huge penalties if Caden doesn’t need this money for school expenses, we are taking our chances that there is a pretty small chance of that happening. Over time, we might open also open a Roth IRA account, earmarked for him, to use a hybrid approach for savings.
In the end, you have to decide what works best for you and your family. But, no matter what you choose, you need to be clear on the pro’s and con’s before you make your decision so you are not surprised by the rules and restrictions down the road.
If you are ready to learn more great tips about savings, grab my free guide: Start Saving Today.
