College Savings Plans: Perks & Pitfalls

by Scott Weingold, Co-Founder College Planning Network

How to save for college

Everyone is well aware of how outrageously expensive college is. One of the hottest topics on the minds of parents today is saving for college, and with so many savings options available to choose from, it can be difficult to know which option is best for your family.

This article is designed to inform you of the different types of college savings plans available today, as well as the perks and pitfalls of each. Before we get started, allow me explain what you’ll definitely want in your child’s college savings plan.

For starters, you want guarantees. That is, you want to know your money is going to be there when you need it to be. The last thing you need is to discover - the day before you need access to it - is that you’re going to lose 40% off the top.  You also want the money to be liquid so you have access to it when you need it. You don’t want your money locked up in something where you can’t get at it.

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Ideally, if there are any tax advantages that are available in the plan, you’ll want to take advantage of them. You’ll also want to factor in how your college savings plan is going to be counted in the financial aid formulas as some assets count against you and others do not.

Now let’s go through six most common savings plans utilized by parents today:

1. Mutual Funds. You can put money that you’re saving for college into stock or bond mutual funds.

Perks: Mutual funds have unlimited potential for growth.

Pitfalls: Mutual funds have unlimited potential for loss. You have to know that if you’re putting your money into mutual funds, the money may not be there when you need it to be. Only you can determine whether it’s a risk worth taking. Also, be aware that mutual funds typically count against you in financial aid formulas — whether they’re held in the parent’s name or the child’s name.

2. 529 Plans. For the right family, 529 plans aren’t necessarily a bad thing. It’s just that I find that many people choose these plans thinking that they’re always the answer to saving for college. I personally don’t think they are. 529 plans – depending on the type of fund that you buy inside the 529 – have the potential for great upside as well as great downside.

Perks: If you use the money for college (on the assumption that the money is there and it’s grown), then you can access the money tax-free.

Pitfalls: There are typically high fees associated with 529 plans. You’re only able to access the money for college; otherwise, you’ll pay a penalty and taxes on top of it. Keep in mind: A lot of these plans haven’t seen any kind of gains in them, so you have to weigh that out.

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3. CDs.

Perks: CDs are FDIC insured currently up to $250,000, so no matter what happens you are guaranteed to get the money.

Pitfalls: CDs count against you for financial aid. Currently, money in a CD pays around 0.25% interest, so they’re not even keeping up with inflation. While CDs are extremely safe, today’s returns are negligible, and they’re going to count against you for financial aid. Therefore, when you factor in today’s low returns and the financial aid implications, you’re almost going backwards.

It’s the same thing with a money market account. Depending on where the money market is held, it may also be FDIC insured, however they’re paying pretty much zero right now. Money market accounts are safe (and I definitely like safe) and you’ll get your guarantees and liquidity, but they are going to count against you for financial aid without real growth potential.

4. Fixed Annuities.

Perks: Fixed annuities are good from the standpoint that they usually have a higher yield than a CD does. The money is typically protected from financial aid formulas.

Pitfalls: With most annuities the money is locked up, and in most cases you’re only able to access 10 percent a year or face steep penalties to get out of them. While some annuities are different, you’ll need to research your options with a financial advisor.

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5. Retirement Accounts. One example of a retirement account is a 401(k) plan.

Perk: While the money in your 401(k) plan doesn’t count against you in financial aid calculations, you’ll want to pay heed to the following pitfalls.

Pitfalls: New contributions made to these plans (once your child hits their base income year – i.e. January 1st of their junior year in high school) will count against you. Also, you can’t just go and take $100,000 and throw it into a retirement account because there are limitations on how much you can contribute. When you’re ready to access the funds, you’ll be penalized for doing so depending on your age and have to pay taxes on it. Additionally, withdrawn funds typically count against you for financial aid. Lastly, this option offers essentially no liquidity or guarantees.

6. Cash Value Life Insurance. Cash value life insurance can be a good tool for the right person, depending on how it’s set up.

Perks: Cash value life insurance offers both guarantees and liquidity. It also offers tax-favored status, whether tax deferred or potentially tax-free, depending on how it’s set up. Cash value life insurance is also typically protected from the financial aid formulas. It has a death benefit so if you happen to die, a big influx of cash can be used to pay for all of your college costs. In all, cash value life insurance tends to be a good program when set up correctly – meaning that it’s over funded so it’s focused on maximizing the growth of the policy and not the death benefit (and the agent’s commission!).

Pitfalls: Depending on how the cash value life insurance policy is set up, you may have to pay penalties to take out money prior to age 59 ½. You also have to be healthy in order to obtain it. While you won’t have the upside potential of investing in a tech fund, growth is slow and steady, so you know exactly what you’re getting. It’s a safe way to save for college.

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About the Author: Scott Weingold, co-founder of College Planning Network LLC and publisher of CollegeMadeSimple.com, is one of the nation's leading authorities on college financial planning. He was ranked the #1 'College Financial Aid Expert Worth Knowing About' in the country by CollegeStats.org and is co-author of The Real Secret To Paying For College. As a sought after speaker, Scott contributes his expertise to CNN Money, Smart Money, and Reuters, and gives insider tips to parents directly through his e-letter College Funding Made Simple. For more information and resources, visit http://www.CollegeMadeSimple.com and http://www.CollegePlanningNet.com. Contact Scott at info@collegeplanningnet.com.

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