Listen and subscribe to Decoding Retirement on Apple Podcasts, Spotify, or wherever you find your favorite podcasts.
The cost of college has more than doubled in the past 20 years, and as a result, families are struggling to plan appropriately for their children’s higher education goals.
According to research by the Society of Actuaries, 6 in 10 Americans have said they delayed their retirement to plan for a family member’s education.
Though a lot of important factors determine the most realistic and cost-effective plan to pay for college, Tricia Scarlata, head of education planning at JPMorgan Asset Management, spoke on Yahoo Finance’s Decoding Retirement podcast about how essential a 529 account can be in ensuring capital goals are met.
“My goal is to always talk about how if you’re not investing and you’re not potentially leveraging a 529 account, you’re missing out on that tax-free growth and compounding over time,” Scarlata said (see video above or listen below). “Cash is just not going to get you there. And so investing and leveraging that tax-free benefit is really what we try to encourage people to do.”
A 529 plan is a tax-advantaged savings account dedicated specifically to saving for future education expenses.
It’s not just for college — these accounts can also be used to pay for trade schools or tuition for K-12 education, offering tax-free withdrawals for qualifying expenses. The money in the account is then invested, compounding with tax-deferred earnings to be used by the designated beneficiary.
“If you just look at the two accounts side by side, a taxable and a nontaxable account, all things being equal, you make a $10,000 contribution upfront, and then you subsequently put in $500 a month — at the end of 18 years, you have almost $42,000 more in the tax-free account,” Scarlata explained, breaking down the difference a 529 account can make when saving for education. “That’s a big amount.”
Read more: How much should I save before going to college?
By adding education plans to your long-term savings goals, you can also avoid the temptation of borrowing against your own 401(k) to pay for a child’s tuition.
“What we do find is a lot of [parents] are borrowing against their retirement to pay those tuition bills,” Scarlata said. “And that’s where I always get concerned, because when you start to borrow against your retirement or your 401(k), what we see is that most people then don’t contribute. A lot of times they’re missing out on that company’s match, and that’s free money.”
She also explained that it’s a common misconception that the money in the account won’t be useful should the designated beneficiary decide not to go to college.
As long as the account has been open for 15 years, up to $7,000 can be rolled over into a Roth IRA for the beneficiary per year, with a lifetime rollover cap of $35,000.
“If you’re able to do that $35,000 over five years, and starting when the adult is 23 — at 65, it’s almost $400,000,” she said.
Read more: How to open a savings account for a child
Though it may seem restrictive to plan in advance for a child’s education, Scarlata emphasized that it’s ultimately more effective for everyone in the long run to do so.
“It’s a family decision,” she said. “And what we have found is that parents do not jeopardize their college savings fund. They almost never take those dollars out early — they wait till that child goes to college and then they withdraw.”
Each Tuesday, retirement expert and financial educator Robert Powell gives you the tools to plan for your future on Decoding Retirement. You can find more episodes on our video hub or watch on your preferred streaming service.
