As a parent of a small child, I’m always fretting: I fret over what she eats — or refuses to eat, which tends to be anything nutritious — how long she sleeps and whether she’ll get hurt. One of my biggest anxieties, though, is whether I’ll be able to stash away enough cash for her future while also saving for my own retirement.
Many financial professionals advise prioritizing retirement savings over college funds, as writer Ruth Davis Konigsberg at Time Money notes. While student loans are a workable, if imperfect, solution for funding college, there’s no comparable, sensible loan option for retirement. Ideally, you’ll build both retirement savings and money for your children’s education at the same time.
The most familiar vehicle for college savings is the 529 plan. Much like a 401(k), a 529 is an investment account with federal tax advantages, letting you save more for your child’s schooling.
My spouse and I set up a 529 for our daughter shortly after she was born. She won’t need it for many years, but with tuition costs on the rise, I’d rather accumulate as much as I can now.
I often ponder what other options exist for saving for my daughter’s future — and for any children I might have later. While a 529 looks ideal, there should be other ways to complement that college nest egg. Instead of just wondering, I decided to research alternatives myself.
Think Ahead
We can’t predict the future, but if your child is older you’ll likely have a clearer sense of what they might do. William Baldwin, writing for Forbes, gives the example of a 10-year-old who could either attend an expensive private university or opt for a more affordable state school.
If the former seems likely, you’ll want to pump as much as possible into the 529 to cover that pricier education. If the latter is more probable, you might choose to stop funding the plan once you hit a target amount, say $100,000.
You don’t want to overfund a 529 because withdrawals used for non-educational purposes are subject to income tax and a 10% penalty. In other words, excess savings not used for qualifying expenses will cost you when you take the money out.
So if your child ultimately attends a state university, you might use only a portion of what you’ve saved. Withdrawing the surplus to boost retirement savings or other accounts would incur taxes and penalties on that extra amount.
Also, the more you accumulate in a 529, the more it can affect your child’s eligibility for financial aid. Savingforcollege.com points out that the effect is limited but real. Typically, if parental assets — including the 529 — are $20,000 or less, they aren’t counted in the expected family contribution calculation.
The EFC calculation will consider up to 5.64% of parental assets above that $20K threshold. Bottom line: the more assets parents hold, the less financial aid a child is likely to receive.
Other Ways to Put Money Away
Don’t want to rely solely on a 529, or want to augment it with other savings? Here are a few alternative ways to accumulate funds for your child’s education.
Savings Bonds
You probably recall savings bonds as a dull gift your grandparents handed you for birthdays.
But savings bonds can be a useful supplemental way to set aside money for your child’s schooling. Ian Salisbury at Time Money explains that “Interest earned on Series I and EE savings bonds is exempt from federal income tax when used to pay for higher education.”
What does that mean in practice? Series I savings bonds are low-risk and accrue interest while you hold them. The current composite rate on Series I bonds is 2.58%, per TreasuryDirect. That outperforms a basic savings account but typically won’t match the potential growth of a 529 investment.
The I-bond rate combines a fixed return set at purchase with a semiannual inflation component.
Series EE bonds carry a much lower yield — about 0.1% — and provide a fixed return determined by the purchase date.
Savings bonds usually offer lower returns than a 529 plan but they tend to carry less risk than putting all your funds into investments.
Custodial Accounts
Another route to consider is a custodial account. Dan Caplinger and Gaby Lapera of The Motley Fool describe these as investment accounts opened for a minor. Unlike a 529, custodial accounts don’t offer federal tax perks, but if balances stay under specified thresholds some income is taxed at the child’s rate rather than the parent’s.
Those thresholds change from year to year, but Charles Schwab notes the first $1,050 is tax-free and the next $1,050 is taxed at the child’s rate for minors under 18. Amounts beyond that are taxed at the parent’s rate.
The main advantage of a custodial account is you can invest in whatever assets you prefer. A 529 frequently limits investment choices, which can be restrictive. If you’re comfortable with investing or work with a trusted advisor, a custodial account might suit you. As with any investment, results depend on how much you invest and what you buy.
Custodial accounts share a downside with 529s: the funds are treated as the child’s assets for financial aid purposes. The larger the custodial balance, the more it can reduce aid eligibility.
Plus, custodial accounts typically must be transferred to the child at age 18. If your goal is to fund college but your teen has other plans, they’re free to spend the money however they wish — and an 18-year-old’s priorities might not include higher education. Unlike a 529, there are no penalties for using custodial funds on non-educational expenses.
If you can, a 529 is still usually the smartest choice for college savings. But if you have extra capacity or prefer to diversify how you save, savings bonds and custodial accounts are sensible ways to spread your contributions.
Marissa Dale is an editor based in Ohio who lives with her husband, their daughter and an elderly dog. She likes running, good food, craft beer and puns.
