When choosing the best option to invest for college, many folks have questions which is the way to go. I’ve seen many people asking, should I use a 529 plan or a high-yield savings account? Unfortunately, I think the question itself stems from a misunderstanding. You can use both at the same time, in theory. It should be noted, however, that this requires an understanding of three things: taxes, risk tolerance & time horizon.
529 Plans
I am a big proponent of using a 529 plan to help pay for college for one major reason: Taxes. The tax benefits within a 529 plan are usually the best you will find when saving for college. It can be treated like a Roth IRA, in that the growth is tax-deferred and qualified education expenses are tax-free. You can also potentially get a state tax deduction in certain states. Needless to say, it’s a great option.
But a 529 plan is an account. It is NOT an investment. It is critically important to distinguish between the 2. Much like an IRA or 401(k), a 529 plan is a tax-favored account that has rules & criteria that can allow for favorable taxable investing. But a 529 plan itself is not an investment.
Instead, investments are chosen within a 529 plan. That’s where you can do both a High-Yield Savings account, and a 529 plan.
High-Yield Savings Accounts
While higher interest rates typically are not accompanied by a growing economy, the advantage they do hold is that savers can often see an increase on guaranteed accounts. But you must know where to look. Online banks typically can offer a higher interest rate, with some banks offering an excess of 5% APY on cash reserve accounts.
The even better part? You can make those savings tax-efficient by investing in a High-Yield guaranteed fund within your 529 plan! You should call your state’s provider/custodian to review the options, but this is a great way for parents to save for students at or near college.
Budgeting & Timing
Thankfully, parents can keep a conservative risk tolerance for those who may need it most, but still earn some interest. The timing of your 529 allocation should be viewed after you properly budget how much you’ll be able to allocate for your child. For example, if I have $20,000 saved in a 529 plan, and I realize I need $25,000 over the four years, I can safely allocate the funds to earn an interest rate that is competitive, while bridging the gap with my cash flow.
Note: The IRS allows 2 529 allocation changes per year. Frankly, there really isn’t a reason to be making more than 2 changes per year. Understanding your budget and investment choices in conjunction with the time horizon and tax benefits make for a winning 529 strategy.
Conclusion
Everyone’s situation is unique, but for many families approaching college, you should be focused on these factors listed. You also want to be cognizant of the fees you pay to an advisor & the fund company. Target funds that have an expense ration of 0.25% or lower, and give serious consideration to working with an advisor who charges a sales charge on mutual funds. By working with a fiduciary, fee-only advisor, you know you’ll get advice that is sound and in your best interest.
