If you’re among the group of parents who are saving something for their kid’s college education — yay! You should be celebrating! Saving money for college is becoming more common these days because let’s face it, the steady increase in college tuition certainly isn’t leaving us with much of a choice.
However, despite your good efforts, I’m sorry to say I’ve come here with the intentions of raining on some y'all's party. I hate to do it, but it must be done. A few of you are saving for your kid’s college education using a regular old savings account and that my friend is one helluva expensive decision. But hear me out before you go and get all in your feelings though.
Ole girl, Sallie conducts a survey every year called How America Saves for College and there are a lot of parents making the mistake of saving using a regular checking or savings account. Based on this report, 40 percent of college savings are being held in savings, checking, or certificates of deposits.
You’re probably thinking, “So what? At least I’m saving?”
Well, yeah — you are saving but most savings and checking accounts earn 1 percent or less in interest every year. That’s nowhere near enough to keep up with the rate of inflation.
You may be leery of this whole investing thing; however, those uncomfortable feelings usually stem from being uneducated about the process. Or a more frank way of putting it — simply not knowing what the hell you are doing.
So for educational purposes only, let’s consider the rate of return on an investment of $2,000 per year. If you invest this money using the proper vehicle — a 529 savings account — let’s see how much you can expect this money to grow.
Let’s say the average rate of return on a 529 account is 5 percent (Note: It’s usually a little higher than this but I’ll be conservative for this example). If you save $2,000 per year, in 18 years you would have a little over $56,000 with a total of $36,000 actually invested.
Now, take this same $2,000 per year (approximately $166 per month) and put it in a savings account with a one percent interest rate and you’ll notice a big upsetting difference. In 18 years, you will only have a little over $39,000 with a total $36,000 contributed out of pocket.
This means your money will only earn $3,000 over 18 years versus the $20,000 earned in a 529 savings account with a 5 percent return (and remember, that was a conservative number just to appease you skeptical folks).
Despite the obvious benefit of a better return on investment, here some other benefits you’ll enjoy when you save for college using a 529 savings account:
- Federal and state income tax benefits.
- Earnings will grow tax free and any withdrawals (including earnings) are tax free (state and federal) as long as the money is used on qualified higher education expenses.
- Less of a negative impact to the federal financial aid your child may receive versus using a savings vehicle that is owned by them (like a UTMA/UGMA account).
- If your child receives a scholarship, you can withdraw the amount of the scholarship from your 529 account without the 10 percent federal tax usually required of unqualified withdrawals.
- Any 529 savings can be transferred to another child or even your own educational expenses.
Many people forgo using a 529 account because they don’t understand the requirements or they might have been misled to believe it will do more harm than good when paying for their child’s higher education.
Don’t be fooled by the misinformation and don’t think you are doing yourself any favors by using a regular old savings account. At this rate, you’ll not only be unable to keep up with the rate of inflation, but your money won’t keep up with the average rise in tuition cost per year.
So consider this a little public service announcement to all of you who are basically stashing your cash under the mattress. There’s a better way to prepare for college expenses! Talk with a financial advisor and choose the best 529 plan for your family.
There are several state specific 529 accounts as well as non-state specific accounts that allow your kid to choose a college anywhere in the country. It’s up to you to choose a plan that’s most suitable for you.
Saving money in a regular checking or savings account is one costly mistake that you’ll end up regretting later. It might not seem like an expensive choice now; however, look at it like this — the less money you have stashed for college will equate to higher student loan balances in the future if your child doesn’t receive scholarships or grants.
A higher student loan balance means paying money in interest and we all know how expensive this can be. So do your child a solid and consider investing in a 529 plan that’ll offers plenty of tax advantages and a greater return for your money. Eighteen years will be in the bag before you know it so sow your seeds wisely and reap the benefits when you’ll need it most.