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529 accounts are a popular and solid way to save money for your children's college. However, the plans do have some drawbacks. Here's a look at several alternative savings vehicles.
Graduation season is here. When I was young, we had two: high school, and, perhaps, college. These days, our kids “graduate” from pre-school, kindergarten, elementary school, middle school, and maybe even taekwondo class! It all may be a little silly, but that doesn’t mean we can’t take advantage of it to start thinking about a key aspect of the future that many retirement savers overlook: college savings plans.
Dentists often enter the workforce in the unfortunate circumstance of having to dig out of several years of dental school debt. The costs of a college education have only increased since then. You may have read that the rate of increase for college tuitions is slowing—and that is true. But that doesn’t mean costs are going down; it simply means the rates at which they’re going up have slowed.
So…if you have kids, and they’re interested either in following in your footsteps or making memories at State Party U, you’re going to need a plan. We’re here to help.
529 Savings Plans
We’ve touched on the benefits of 529 plans previously, and these plans are popular for good reason. They give you control over your choice of investments and beneficiaries, plus the opportunity for tax-free earnings and withdrawals that are free from federal and some state income taxes. Any earnings in 529 plans are automatically reinvested in the plan—which makes them both easy to use and beneficial over long saving windows. Most 529 plans carry fees, and there is some risk involved, including inflationary risk, which is when your investment grows so slowly that it doesn’t keep up with inflation.
Other Choices Abound
529 plans are popular, but they certainly aren’t the only choice. One of the tenets of the plans that give investors pause is that they are relatively restricted in their use. If your child doesn’t end up wanting or needing the funds, you will pay some penalties—in some cases, pretty stiff penalties—to free that money up for other uses.
Coverdell savings accounts offer more freedom than 529 plans because they have fewer restrictions on what investments you can make. The trouble with Coverdell plans is that their $2,000 limit per child can make it feel like you’re barely putting a dent in your future cost load.
A simple investing strategy set aside for minimal but long-term growth is an interesting alternative. If you have an advisor you work closely with, talk to them about your long-term savings goals and whether a strategy that invests in blue-chip, dividend paying stocks (such as Microsoft or Coca Cola, among hundreds of others), or an exchange traded-fund (ETF) geared for low risk and steady growth. As with a 529 plan, and, really, any investment, there is a risk of losing even the principle of the investment, but these risks can be mitigated somewhat through diversification.
Roth individual retirement accounts are also used frequently for college savings purposes. Roths are IRAs that are paid with already taxed money. For many retirement savers who are at the upper limits of their 401(k) maximums, Roths are used as a supplemental retirement saving vehicle. They include a solid feature that allows the funds from a Roth to be withdrawn without penalty prior to age 59½ if the money is used for higher education expenses. Roths have their own contribution limits as well, and there are some important restrictions, but, again, the key benefits are flexibility and the opportunity for slow, steady growth.
Long-term bonds, such as tax-free municipal bonds, also make sense for some collage savers. Municipal bonds are more flexible than 529 plans, and they can be held in parents’ names so that your college age children won’t be on the hook for any investment income. Municipal bonds may be less risky than stocks, but they also have less potential for growth.
You may look at all those options and come back to a 529. Just be aware that there all alternatives that may, depending on your overall investing goals, bet a better fit.