College costs continue to soar, making it more important than ever to help save for your kids' college education. But what's the best way to save?
Advocates of college savings plans have dubbed May 29 "529 Day," referring to the section of the Internal Revenue Code that authorizes the tax-favored accounts known as 529 plans.
But many parents don't realize that there are alternatives to 529 plans that can often produce even better results for those looking to make the most of their college savings. Looking at alternatives allows you to take a more holistic approach to your overall college-savings strategy.
Why 529s Aren't Your Only Choice
There's no dispute that 529 college savings plans are extremely useful as part of a successful strategy for building an investment portfolio to use toward paying your children's college costs. With key tax benefits like tax-free treatment for investment income that you use toward permitted college expenses and very high contribution limits, 529 plans offer advantages you won't find in other savings options.
But 529 plans aren't always the best move for every investor. With some 529 plans, limited investment options and high cost levels for mutual funds and other underlying investments make them less attractive as long-term savings vehicles, despite their tax advantages.
1. Coverdell Education Savings Accounts
Coverdell Education Savings Accounts or ESAs give you a lot more flexibility to make exactly the investments you want toward your children's college education. Unlike 529 plans, Coverdell ESAs have almost no restrictions on what investments you can make, with brokerage accounts giving you access to a full selection of stocks, bonds, ETFs, mutual funds, and other types of investments. Yet ESAs share the favorable benefit with 529 plans that the income they produce is tax-free when you use it for educational expenses.
The challenge with Coverdell ESAs, though, is the low limit on contributions. Currently, the limit is just $2,000 annually, meaning that even if you're diligent about setting aside the maximum each year, it will only make a small dent in your child's financial needs for college.
2. Custodial Accounts
With a custodial account, you hold money as custodian for your child. Different states have different laws covering custodial accounts, but generally, you can open an account in a child's name and manage that money in whatever investments you want. The account gets treated as a regular taxable account for tax purposes, but the benefit is that income is attributed to your child's tax return rather than your own, often qualifying for advantageous tax rates at least for some of the income from the account.
Custodial accounts do come with two big challenges. The one that makes most parents uncomfortable is that you're legally obligated to give control of the account to your child at the age of majority, which is typically 21. In addition, financial aid treats custodial accounts as available for the child's contribution to educational expenses, which can lower the amount of outside support your child receives.
3. Keeping College Savings In Your Own Account
Finally, one simple thing many parents do is just to keep an investment account in their own names that they know is earmarked for their children's education. By doing so, they can keep managing their own investments the way they always have, sometimes taking advantage of cost savings from aggregating their assets in a single account.
The downside to this strategy is that income is fully taxable at your own usually higher tax rate. But because financial aid calculations treat parental savings more favorably than the child's own savings, holding onto your own money might actually be advantageous compared to a custodial account even with potentially higher tax liability.
The Right Mix for Your Kids
The best answer for most families involves a combination of these strategies.
Finding low-cost 529 plans with index funds as a core portfolio can get you most of the way to your savings goals.
Then, you can use the limited funds you're able to invest in a Coverdell ESA to make targeted investments in stocks that you're most confident about.
Investing just enough in a custodial account to take advantage of your child's favorable low tax rates can limit any concerns about financial irresponsibility down the road.
Finally, keeping some funds on hand in a regular brokerage account hedges against the possibility that you might need money for needs other than those that qualify for college-savings tax breaks.
Delayed Launch: How (and Why) to Delay Your Entry into the Job Market
3 Smart Alternatives to 529 Plans to Help Pay for College
The classic method for avoiding the job market, graduate school has the added benefit of -- under the right circumstances -- making you look even more attractive to employers and recruiters. On the other hand, a poorly-chosen degree can also leave you with even more debt and no improvement in your job prospects.
If you qualify for a fellowship, assistantship, or scholarship that will cover your tuition costs and give you a stipend, going for an advanced degree becomes a no-brainer. While grad stipends are far from princely, with careful planning, you may be able to get out of grad school with no increase in debt, a degree that will likely improve your employability, and a shot at job-hunting in a friendlier environment. That being said, it especially helps if your degree is in a high-paying field. Georgetown University's Center on Education and the Workforce offers some useful information on choosing the advanced degrees with the best returns on investment.
There's an old saying: If you have to pay for grad school, you probably shouldn't be there. In other words, if you can't get an assistantship or fellowship, you might want to reconsider your postgraduate education. For that matter, if you're carrying a lot of private student loan debt, you might want to hold off even for a program with a stipend: Those loans, unlike the government-backed variety, won't be deferred while you're in grad school, so if you take one of those not-so-generous stipends, keeping up with your payments will likely be difficult.
Another classic method for postponing the day you have to get a "real" job, the Peace Corps gives young people the opportunity to travel the world, see exciting things, and make new friends. And, when you get back, you'll have the added benefit of foreign language skills and a great line on your résumé.
If you're interested in seeing the world, aren't averse to living surrounded by extreme poverty, and aren't carrying much private loan debt, the Peace Corps can be a great choice. During your time in the corps, your federal student loans -- and some private loans -- will be deferred, and your Perkins loans may even be partially forgiven. And, when you get back home, you'll have a readjustment allowance to help you get back into the swing of things.
The Peace Corps doesn't pay much, which can make your financial life difficult if you're carrying a lot of private loan debt. For that matter, the Corps has recently had problems with ensuring the safety of its volunteers, which could be a serious problem, depending on where you're posted. Beyond that, if you aren't sure you'll be able to adapt to living in rougher circumstances, surrounded by extreme poverty, you may want to think twice about signing up.
If you're looking for a way to enter into the teaching profession, or if you just want to try out being in front of a classroom for a few years, consider Teach for America. The program places college graduates into low-income classrooms across the country, offering them a salary, loan forbearance, money for education, and -- when they leave -- up to $6,000 in loans and grants to help them get reintegrated into society.
If you're interested in teaching, are enthused about the idea of working with low-income students, and don't have a lot of outstanding private loans, Teach for America can be a great bet. It looks good on a résumé, and is an excellent way to get started in teaching.
This is going to start to sound repetitious, but it keeps applying: if you're carrying a lot of private loan debt, Teach for America may not be for you. Even if you can get a deferment on your loan, you'll still be accumulating interest, which will leave you further in the red. Beyond that, if you are uncomfortable living and working in lower-income areas, this program is definitely not for you.
Interested in joining the Peace Corps, but don't want to get vaccinated for yellow fever? If so, AmeriCorps might be the choice for you. Working in education, public safety, environmental protection and health care, it places volunteers with dozens of different programs. Depending on your placement, AmeriCorps service could land you in a classroom or the field, building houses or working with FEMA. Benefits also vary greatly, depending on the program, but can include a living allowance, childcare stipends, an education benefit, and some health care.
AmeriCorps members may qualify for up to $5,550 in education assistance, which can be used to pay off existing loans or to fund further schooling. Additionally, the childcare allowance can make it more attractive to people with children. And, as an added benefit, your volunteer work could help you pick up some marketable skills.
AmeriCorps' education assistance is not as impressive as the benefits offered by other programs, which may make it less attractive if you're carrying a heavy student loan burden. Also, because the work placements vary so widely, there's a good chance that your skills may not be all that marketable.