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In last week's column, I wrote about figuring out how much to contribute toward your child's college education and determining what you can reasonably afford. So your work is done, right? Oh, if only it were so simple. Now you have to figure out where to save the money.
Many people automatically think 529 plans when it comes to college savings. More on these in a minute. But there are other avenues for saving. Ginger Ewing, an Ameriprise Financial adviser in Inver Grove Heights, suggests that parents who don't have loads of money to save for college begin with a Roth IRA.
"The Roth gives parents the most flexibility to decide how to use that money later. Really, it's a retirement account, but you can take out original contributions whenever you want, tax-free," she explained. If you need the original contributions for college, that's fine. But if you have some left over, your retirement nest egg just got a nice boost.
When the stock market took a dive in 2008, some parents who diligently saved for college found themselves staring at sizable losses -- and a freshman tuition bill. For a less-risky approach, Mike Branch, a certified financial planner with Focus Financial in Roseville, suggests tax-exempt bonds and bond funds.
"It's a way to invest long-term that's more conservative, that gives you an additional tax-free benefit," he said.
College 529 savings plans also are known for their tax advantages. These state-sponsored plans are funded with after-tax dollars, and the money grows and is withdrawn tax-free for qualified education expenses such as tuition and textbooks. They're also flexible, to a point. There's no contribution limit, and the beneficiary can be switched so siblings and even parents can dip into the same 529 plan. Unlike custodial accounts, the adult maintains control.
529 plan limitations
However, if the money is ultimately used for something other than approved higher education costs, the earnings will be taxed and hit with a 10 percent penalty. And it won't cover every single expense associated with going to college. Plane tickets to and from school can't use 529 funds, for example.
Since 529 plans won't cover all college-related bills, Laura Kuntz, a Bloomington-based financial adviser with Raymond James, has her clients invest one-quarter to one-third of the money dedicated to college in an account other than a 529 plan.
Regardless of where you live, you can open a 529 plan sponsored by any state and use it for schools in any state. I'd keep an eye out for one with low fees and several investment options, and would open it directly with the 529 plan and not through a financial adviser, because buying direct tends to cost less.
While the TIAA-CREF-run Minnesota College Savings Plan fits the bill, it's in one of just seven states with a personal income tax that doesn't offer a tax break for contributions, according to the Minnesota Office of Higher Education. (Although families residing in Minnesota that make $80,000 or less qualify for a small matching grant.) So why not shop around? Morningstar.com and savingforcollege.com are good places to start.
Once you decide where you're going to keep the money, the next step is choosing the investment. With Roth IRAs, the options are practically limitless. With 529 plans, there are fewer choices, but the options range from 100 percent stocks to a money market fund and every flavor of risk in between.
To make this decision you must ask yourself: How much risk are you willing to take? If you are saving for your future offspring, putting some of the money in equities would make sense because you have a longer time horizon. If your child is filling out college applications, that's a different story.
"The key thing that people need to be aware of is that stocks are volatile," Kuntz said. "By the time the kid is about a junior, but for sure a senior in high school, it should be in the money market, or the stable income fund or the low-duration bond fund. It should be in something stable, so they have a count-on-able amount of money."
Many parents who use a 529 plan pick age-weighted funds -- a mix of stocks and bonds that shifts to a more conservative allocation as the child nears college. But don't just assume that these age-weighted options are right for you. You may not feel comfortable taking that level of risk with your child's college money. If that's the case, Kuntz says one easy fix is to put most of the money in an age-weighted fund and the rest in bonds or if available, a guaranteed option that earns a small return but has no risk.
Also note that while age-based options are standard in 529 plans, the asset mix won't be identical from company to company. Be sure you understand what you're buying and keep tabs on the investment. This money lays the foundation for your child's future.
Where do you save for college? Kara McGuire • 612-673-7293 or firstname.lastname@example.org.