Sandwich Generation: How to Save for College
A 529 plan provides tax benefits for parents and grandparents. Here’s how to find a good one.
Jeff Brown writes a biweekly blog about the Sandwich Generation and the financial issues its members face as they try to help their parents and their adult children. The blog appears on Next Avenue and on the website of the public television show Nightly Business Report. A financial journalist, Brown brings personal expertise to the subject: He is part of the Sandwich Generation.
With our son, Dash, headed for college in the fall, my wife and I are neck deep in the swirl of college-financing issues. We’re extraordinarily grateful for the college investments my mother set up for him more than a decade ago. Her contributions, along with ours, let us focus on our top priority: Seeing that Dash will be able to go to the best college that accepts him.
Financing a child or grandchild’s college education is probably the most common form of Sandwich-Generation giving, at least when it comes to giving large sums to family members. So what’s the best way for parents and grandparents to do it?
Let me, like Benjamin Braddock’s college-graduation party guest in The Graduate, reveal the magic word: Section 529. OK, technically that's two words. But state-sponsored 529 college savings plans (named for Section 529 of the Internal Revenue code) are far and away the most valuable way to invest for college, mainly because the investment gains grow tax-deferred and withdrawals used for education are free of federal taxes and often state taxes, too.
The Advantages of 529 Plans
As with other financial gifts, you can give each 529 recipient up to $14,000 this year without owing gift taxes. Better yet, the 529 rules allow you to make five years worth of contributions for college — $70,000 — in one lump, as long as you don’t give that child or grandchild any more 529 money during that period. Two parents or grandparents can give a child $28,000 for a 529 this year or a lump sum of $140,000 covering the next five years. (Of course, if you don’t care about the gift tax, you could give more.)
A 529 account remains under the control of its owner, typically the person who set it up, but the money in it can be transferred to another recipient, which can be helpful if the original recipient does not go to college or gets a whopping scholarship. Colleges that qualify for 529 plans are any colleges, universities, vocational schools or other postsecondary education institutions eligible to participate in a student aid program administered by the U.S. Department of Education. (You can use a 529 for your own education expenses, as an adult, too.)
Keep in mind, however, that earnings from a 529 spent on something other than college costs will be subject to a 10 percent penalty and income taxes. (The penalty is usually waived if the assets aren’t used for college for certain reasons, like a scholarship or the student’s death or disability.)
These plans also enjoy favorable treatment in the widely used federal student aid formula; their assets do less damage to aid eligibility than most other types of college savings. (Reminder: Many colleges have an early February deadline for filing the government’s Free Application for Federal Student Aid, or FAFSA.) And 529 accounts properly set up by grandparents don’t undermine eligibility at all.
One Drawback to 529 Plans
So what is the biggest downside of 529 plans?
Well, shopping for a 529 can be a real headache.
The plans are set up by states, each with its own rules and investment options. You can usually choose any state plan that you like and use the proceeds at any college in the country. But your state’s plan might not be your best choice. Its investment track record may pale compared with competitors’ or your state’s plan could have higher fees than other ones.
There’s one advantage for going with your own state’s plan: You may get a state-tax deduction for your contributions.
The Best 529 Plans
Fortunately, Morningstar, the outfit known for helping investors select mutual funds, produces an annual list of what it considers to be the best 529 plans.
In its latest list, Morningstar recommends 27 plans and gives highest marks to these four:
- Alaska’s T. Rowe Price College Savings Plan
- Maryland's College Investment Plan
- Utah's Educational Savings Plan
- Nevada’s Vanguard 529 College Savings Plan managed by Upromise Investments
How to Research 529 Plans
If you’ll be looking for a 529 plan, here’s my advice on how to do your research:
Investments Think of selecting a 529 as something similar to shopping for a mutual fund. Each 529 plan typically offers choices from underlying mutual funds — you can pick one matching your investing preference, from conservative to aggressive.
If the beneficiary is very young, an aggressive choice that’s heavy on stock funds might be best. Odds are a stock fund will provide the biggest gains for investors who stick with it long enough to wait out the downturns. If college is just a few years away, you’d want a more conservative approach focused on bonds and money-market accounts.
You might want to go with a target-date fund whose date matches the child’s expected freshman year. These funds invest in aggressive stock-heavy portfolios when a child is young, then gradually shift toward bonds and cash as the college years approach, when safety is the priority.
Fees You should also try to minimize fees when picking a plan. Unless you need a lot of hand-holding and are willing to pay steeply for it, go with a plan sold directly by the mutual fund company that manages it, rather than one from a stockbroker. Frankly, when it comes to low fees, I’d look for plans on the Morningstar list and call it a day.
Prepaid 529 Plans
You might want to think about using one of the prepaid tuition 529 plans offered by 15 states.
With these programs, typically either the donor or beneficiary must be a state resident because the money will pay for a designated college in their state, generally a public university. The idea is to lock in tuition at today’s price to avoid the higher bills you’d most certainly pay later, when the beneficiary is college age. If the beneficiary doesn’t wind up going to a school in the pre-paid plan, the balance can be converted to the value of the school’s tuition at the time and applied toward another college.
With tuition rising faster than inflation, pre-paid plans could be a good deal. But a number of these plans have run into financial trouble. Some have resorted to charging “premiums,” requiring participants to pay more than a credit hour currently costs. The Savingforcollege.com article, “Is There a Prepaid 529 Plan in Your Future?,” shows you how to find programs with the best financial backstops.
Families Need to Coordinate
Like many families, we’ve saved for college in various ways.
We have about a semester’s worth of prepaid Penn State tuition credits that my wife and I bought about five years ago. We also have a couple of stock-oriented 529s — one set up by my mom and one by my wife and me. And we have ordinary taxable investments that could be used for Dash’s expenses not covered by a 529, like a car, travel to college and spending money.
For a Sandwich Generation family using multiple approaches to saving for college, as we have, the key is coordination.
Parents and grandparents need to know what each is doing to avoid potential tax pitfalls. If too much 529 money is withdrawn for the year’s college expenses, for instance, the family would face taxes and penalties.
My last piece of advice: If college is looming for your child or grandchild, start boning up on ways to pay for it, then begin putting as much money away as you can afford. Savingforcollege.com, the grandfather of all 529 sites, is a great place to learn the basics. Think of this process as your education to pay for a loved one’s.