For some parents, saving for their children's college education can take priority over even saving for their own retirement. But choosing an investment strategy for a college-savings goal can feel a bit like choosing a college and major, with a wide array of options that have different benefits.
The 529 plan, a college savings investment account typically operated by a state, is among the more popular ways to get a proactive financial footing ahead of rising college costs. And, with its tax-sheltered investments, a 529 plan can offer a substantial boost toward funding both in-state and out-of-state college expenses.
"Tax-free growth is very rare in an account," said Andrew E. Carrillo, a CFP for Barnett Capital in Miami. "Over time, it can really do a lot. Especially if you start right when the child is born."
"You can tell friends and relatives about the account," Carrillo added. "So instead of buying them a toy when they're 3 or 4 years old, they can just write a check to put in your education account. Once people know that exists, anyone can give money."
And the it-takes-a-village mentality may be all the more essential when planning ahead for college. The cost of in-state, undergraduate tuition at a public four-year school rose 2.9% to $7,350 for the 2015-2016 school year from a year prior, according to the College Board's 2015 College Pricing report. Meanwhile, trends in financial aid have not kept pace and inflation the past year has been about 1.4%.
Through 529 plans, parents and their friends and family can contribute an unlimited amount per year (although annual contributions over $14,000 are subject to a gift tax). The capital gains on those investments, which can range from risky stocks to conservative bonds, will not be subject to income tax when they are withdrawn. The money must go toward tuition or a college-related expense like tuition, room and board, computers or books to be exempt from taxation. But parents have other options for the money if their child does not go to college.
The person who initiated the 529 account is its owner, but the funds must be used for the beneficiary's benefit to get the tax exemption. However, you can change the beneficiary whenever you want. So if you don't use it all for one child, you can use it for another child.
If the money is not used for an educational purpose, it can also simply be withdrawn and taxed as it would if it were in a brokerage account.
It's for that reason - that the money could be used for other purposes with no additional tax benefit - among others that has advisors like Roger Pine, CFA with Briaud Financial Advisors in College Station, Texas, steering clients away from college-specific investment accounts.
"We make college to be this big looming scary expense in our future," said Pine. "We understand the value of it and what it means for our children's future so we treat it differently. And I'm not sure that's always the way to approach it."
Although 529 plans do offer tax benefits, Pine said they come at "a price that we think is too high and not worth the trouble." These plans do include trading constraints that limit how often you change investments to only twice per year, which may not be ideal in today's more volatile trading environment.
Also, many investors may find they could better benefit by having the money in a more fluid account where it could be used for emergencies.
Saving for college is "always a little different for each family," Pine said. "But we say lump it in with your normal savings and budget for it."
This article is commentary by an independent contributor.