MONEY College

My Son Isn’t Going to College. Now What?

College savings seemed to go according to plan, but now the beneficiary has strayed from the script, and the parent is worried he'll get the funds.

Q. My son is turning 18 and I’ve saved more than $200,000 for him for college. He doesn’t want to go. Some of the money is in UTMAs, some in a 529 Plan and some in savings bonds. I don’t want him to live off the money and not get a job. Help!

A. Bet that threw you for a loop.

Each of the kinds of assets you saved for your son is treated a bit differently, so let’s take stock of what you have.

Custodial Accounts

The assets you saved in a custodial account — Uniform Transfer to Minor Act accounts, or UTMAs — will be his when he reaches the age of majority, said Bryan Smalley, a certified financial planner with RegentAtlantic Capital in Morristown.

In New Jersey, the age of majority is 21. That means that there are three more years before the assets officially become your son’s.

“A lot can happen in the next three years: your son could start a career and be self-sufficient — therefore not needing the money to support his lifestyle — he could start his own company and use the UTMA funds to help grow the business, or he could end up deciding to go the college,” Smalley said. “Who knows, a few years of earning minimum wage and seeing all of his friends move on with their lives may be all the motivation he needs to hit the books once again.”

The 529 Plan

The 529 account is different. As long as you’re the owner of the account, you retain control of the funds and there is no time limit on when you need to use them,” Smalley said.

If your son decides to go to college in a year or two, the funds will be there.

“If your son does not go to college, you can always use the funds for another of your children’s college education — if your son is not an only child — or hold onto the account and use it for a future grandchild’s college education,” Smalley said.

Savings Bonds Earmarked for College

If either of those options are not of interest to you, you can always withdraw the funds from the 529 account and use them elsewhere, Smalley said. But that move comes with a price. You’ll have to pay a 10% penalty plus taxes on the earnings in the account if you use the funds for anything other than qualified higher education expenses.

On your savings bonds — assuming they are either EE or I bonds — if they are owned in your name, your son does not have a right to them even though they were purchased with the intent to pay for his college education, Smalley said. You may continue to hold onto them or cash them in.

“Please note that if they are not used to pay for higher education expenses the interest on the bonds is not deductible on your tax return,” Smalley said.

If you purchased bonds in the name of your son, you can have them reissued in your name. The caveat here is that you cannot have them reissued if they were purchased with your son’s own money, such as with money from an UTMA.

“As you can see, not all is lost. While it must be disappointing that your son does not want to go to college now, it is not an irrevocable decision,” Smalley said. “He could always change his mind and go later or perhaps he finds his success on a path that does not travel through a college education.”

More from Credit.com

This article originally appeared on Credit.com.

MONEY Ask the Expert

This Formula Can Help You Figure Out How Much to Save for College

Ask the Expert - Family Finance illustration
Robert A. Di Ieso, Jr.

Q: “My husband and I have been saving for our kids’ college since they were born. They are now 4 and 6. Our initial plan was to just throw what we could into a savings account, then we moved that money to a 529. We make small monthly contributions, and also contribute some money whenever we get a bonus or they get a birthday gift from grandparents. However, we still don’t have a number in mind for what we actually need by the time they start school. How much should we be saving for them each month?” —Ryan Phelan

A: Congratulations for starting the saving process early and taking full advantage of compounding in that 529 account. That’s less money you’ll have to borrow later.

Now for the bad news: By the time your eldest child enters college, four years at an in-state public school will cost an average $130,000 and a private-school education will run $235,000 if prices continue rising at the rate they have for the last five years.

Footing the full freight will be unrealistic for most folks, especially those like you who have more than one child to put through school. Besides, you should also be saving for your own retirement—since you can’t fund that stage of life with loans as you can your kid’s education.

Mark Kantrowitz, author of Filing the FAFSA and senior vice president of the Edvisors Network, offers a more reasonable goal: Try to save a third of your kids’ expected college costs by the time they’re on campus. The next third can come from income (plus grants and scholarships) at the time tuition needs to be paid, and the final third you or your kid can borrow.

The idea is to spread the cost out over time to make that staggering price tag more manageable, says Kantrowitz. You’re putting together past income (what you’ve saved), current income (while the child is in school), and future income (yours or your child’s to pay back the loans).

So in your situation, a good goal would be to put away at least $43,000 or $78,000 for your eldest child, depending on whether you’re aiming to pay for public or private school.

You can estimate a savings number for your younger child—and anyone else can figure it out for their own kid—by figuring out the full cost of an average college education the year the child was born, since college costs increase by about a factor of three over any 17-year period, says Kantrowitz.

For help translating the big number into what you need to save each month—based on your state, income, children’s ages, and current 529 savings—use this 529 college savings planner tool from Savingforcollege.com.

More from Money 101:

Where should I save for college?

How much should I save for college vs. retirement?

What’s the best 529 plan for me?

MONEY College

How College Costs Will Change in 2015

Although college costs are still increasing, they're increasing at a much lower rate than they have in recent years. Interest rates and repayment for federal loans have eased as well.

MONEY College

How to Give the Gift of College This Holiday Season

stacks of money wrapped with a gold bow
Deborah Albers—Getty Images

The kids in your family could probably use cash towards school more than a new toy (or at least parents might prefer that). Here's how to make it happen.

Saving for college can be tough, but many families do not tap a potentially generous resource: relatives and friends.

Various companies are trying to change that by making it easier for parents to ask for, and receive, contributions to college savings plans. As the holidays approach, these providers are stepping up their efforts to publicize these options and convince families to try them.

“I think people can feel comfortable going out and saying they prefer gifts that are more meaningful,” says Erin Condon, vice president of Upromise, a college savings and cash rewards program, run by Sallie Mae.

“They can say, ‘Instead of giving our son a truck, how about helping us save for college? Or giving him a smaller truck and putting $20 into his college savings plan?'”

Named after Section 529 of the Internal Revenue Code, 529 college savings plans allow contributors to invest money that can grow tax-free to pay for qualified higher education costs.

Although typically sponsored by states, the plans are run by investment companies and account balances can be spent at any accredited college or vocational school nationwide.

Upromise released a survey last week that found seven out of 10 parents would prefer their children received money for college rather than physical gifts. Upromise offers a way to let others do just that: it is called Ugift, a free online service that families can use to solicit their social networks for college contributions.

Friends and family are emailed bar-coded coupons they can print out and send in with a paper check. The service is available to customers of the 29 Upromise-affiliated 529 plans, which include two of the country’s largest: New York’s 529 College Savings Program and Vanguard 529 College Savings Plan in Nevada.

Upromise has found that customers who enlist others to help them save via the site’s rewards program and shopping portal typically accumulate three times as much as customers who do not, Condon says.

The 529 plans run by Fidelity Investments also offer a free service that allows parents to set up a personalized contribution page and share links via email or social media that allow direct contributions to a child’s college savings account via electronic check.

Fidelity released its own poll recently, which found 9 out of 10 grandparents surveyed said they would be likely—if asked—to contribute to a college savings fund in lieu of other gifts for a holiday, birthday or special occasion. Fidelity manages 529 plans for Arizona, Delaware, Massachusetts, and New Hampshire.

These programs tap into the crowd-funding zeitgeist that has seen people appealing to their social networks to help pay for creative projects, charitable causes as well as personal costs such as medical expenses, travel and weddings.

As college costs rise, more people see the need for such help, according to Joe Hurley, founder of the 529 information site SavingForCollege.com.

“It’s a reaction to material gifts, and also the rising cost of college that’s creating so much anxiety for parents,” says Hurley.

Create a College Registry

A few sites facilitate contributions to any 529 plan. GradSave, for example, lets parents set up a free college savings registry that accepts contributions from friends and family. The money is held in an FDIC-insured account until the parents transfer it to their 529 accounts.

Leaf College Savings, meanwhile, offers an education gift card that anyone can use to make a 529 contribution for someone else. The giver loads an amount between $25 and $1,000 onto the card and gives it to the parent, who can then redeem it at the Leaf site and transfer the funds to his or her 529 plan. If the parents do not have a plan, the site helps them set one up.

The gift card, however, comes with an “activation fee” of at least $2.95 plus another $2.95 to get a physical card rather than one sent by email or Facebook or printed out on your computer.

But givers do not need an intermediary to contribute to a college savings plan, says Hurley, since virtually every 529 plan accepts third-party gifts. Those who want to contribute directly to a child’s account typically will need to include the account number and perhaps the child’s Social Security number, but Hurley notes there is a way to bypass that requirement.

“Just make the check out to the 529 plan, hand it to the parents and say, ‘Here, put it into the plan,'” he says. “That’s pretty easy.”

One thing that may not be easy is figuring out who gets the tax break for the gift. Most states offer tax deductions for 529 contributions when the contributor is a parent. Some offer the break to any contributor. And some do not offer any tax break at all.

The solution? Talk to your tax professional.

Related: More on college savings plans

MONEY college savings

One Foolproof Way to Earn More on Your College Savings

handing money over
PM Images—Getty Images

Tax breaks, matching grants, and scholarships can effectively boost your investment by an average of 6%.

Savers in many states don’t have to rely solely on the markets to build up a college fund. Grants or tax benefits can effectively boost the value of your investment in a 529 college savings plan by 10%, 20% or even 30%, according to a newly released analysis by Morningstar.

In the 32 states (plus the District of Columbia) that offer subsidies to college savers who contribute to their home state’s 529 plan, the average benefit is a one-time boost worth about 6%.

In New Jersey, parents who seed a NJ BEST 529 account with $1,200 when their kid is about six and kick in at least $300 a year after that will qualify the student for a one-time $1,500 freshman scholarship to an in-state public university. That’s a return of 31.5% on a total investment of $4,800.

Most states simply give parents a tax credit or deduction for a 529 contribution, which translate into a lower state tax bill and thus more money in your checking account. That’s money you can use for anything—including adding to your 529 or offseting the cost of saving for any college.

Residents of Indiana, for example, qualify for a state tax credit worth up to 20% of what they invest in the state’s 529 plan, which can reduce a typical family’s state tax bill by $480. Vermonters get tax breaks typically worth 10% of their investments in their local 529 plan.

Five states offer tax breaks for an investment in any 529, allowing residents to shop for the best plan anywhere. Two of those five states reward both choices: Maine offers a 1.7% tax benefit for any 529 investment, but also provides matching grants for saving in the state’s 529. Pennsylvania’s has tax breaks worth about 3% for any college savings, but it also offers scholarships to hundreds of mostly private colleges across the country for those who invest in-state.

Fifteen states either have no income tax or don’t offer any subsidy to college savers. Check out this 50-state map to see whether to invest in your state, or out of state.

Beware of the Gotchas

The author of the Morningstar report, Kathryn Spica, says you should watch for two big potholes when trying to maximize these freebies.

1. High fees: Some states charge such high fees in their 529 plans that any parent with a child younger than, say, 13 should probably forgo the tax benefit and choose a low-cost, highly-rated direct-sold plan. But for parents of teens close to college, the immediate tax benefits can outweigh only a few years of higher fees.

For example, D.C. offers tax breaks that amount to a one-time 8.5% effective boost to your college savings. But D.C.’s plan charges a high annual fee of 1.35% of assets. Utah’s plan, which gets the highest rating by Morningstar, charges only 0.2%. Within eight years, D.C.’s higher fees would likely eat up your tax benefit.

2. Changing rules: North Carolina cancelled its tax break for 529 savings last year. And Rhode Island has stopped enrolling new parents in its savings match program, Spica says. Parents in states that end or slash tax benefits should take a few minutes to run the numbers and see which investment option best meets their needs.

The Value of the Tax Breaks

The chart below lists the states that offer benefits for investing in the home state 529 as of fall 2014. Morningstar’s estimated value of the subsidy is based on a family earning $50,000 a year and saving $2,400 a year for college. The fees are those charged for an age-based fund for a 7- to 12-year-old that employs a moderate (as opposed to conservative or aggressive) investment strategy.

The final column is Money’s recommendation on whether parents of kids younger than 13 should stick with their state’s best 529 option, or risk giving up the state’s benefit and shop for the best plan nationally.

If your state is not listed here, you won’t be giving up anything if you simply pick the best plan available. Here are Money’s recommendations for the best 529s nationally, based on a combination of the fund’s fees, the state’s tax benefits, and the ratings given the plans by Morningstar and Savingforcollege.com.

State Est. value of state tax benefit on savings of $2,400 a year Effective yield on $2,400 investment Average fee for moderate equity plan for 7- to 12-year-old Should parents of kids under the age of 13 invest in-state or shop?
Indiana $480 20% 0.57% In-state
Vermont $240 10% 0.45% In-state
Oregon $216 9.0% 0.38% In-state
District of Columbia $204 8.5% 1.35% Shop
Idaho $178 7.4% 0.75% In-state
Arkansas $168 7.0% 0.60% In-state
South Carolina $168 7.0% 0.12% In-state
Montana $166 6.9% 0.88% Shop
Iowa $156 6.5% 0.26% In-state
New York $155 6.5% 0.17% In-state
Wisconsin $150 6.3% 0.23% In-state
Georgia $144 6.0% 0.33% In-state
West Virginia $144 6.0% 0.32% In-state
Maine $140 5.8% 0.30% In-state
Virginia $138 5.8% 0.61% In-state
Oklahoma $126 5.3% 0.51% In-state
Alabama $120 5.0% 0.32% In-state
Connecticut $120 5.0% 0.40% In-state
Illinois $120 5.0% 0.19% In-state
Mississippi $120 5.0% 0.65% Shop
Nebraska $120 5.0% 0.48% In-state
Utah $120 5.0% 0.22% In-state
New Mexico $118 4.9% 0.36% In-state
Maryland $114 4.8% 0.88% In-state
Colorado $111 4.6% 0.39% In-state
Michigan $102 4.3% 0.28% In-state
Louisiana $96 4.0% NA In-state
Ohio $90 3.8% 0.23% In-state
North Dakota $68 2.8% 0.85% Shop
Rhode Island $38 1.6% 0.20% In-state
Pennsylvania Variable N.A. 0.38% In-state
New Jersey Up to $1,500 N.A. 0.77% In-state can pay if student definitely will attend a participating college
MONEY 529 plans

Why the Best College Savings Plans Are Getting Better

stack of money under 5-2-9 number blocks
Jan Cobb Photography Ltd—Getty Images

Low-cost 529 college savings plans continue to rise to the top in Morningstar's latest ratings.

Competition is creating ever-better investment options for parents who want to save for their kids’ college costs through tax-preferred 529 college savings plans, according to Morningstar’s annual ratings of the 64 largest college savings plans.

In a report released today, the firm gave gold stars to 529 plans featuring funds managed by T. Rowe Price and Vanguard. The Nevada 529 plan, for example, which offers Vanguard’s low-cost index funds, has long been one of Morningstar’s top-rated college savings options. The plan became even more attractive this year when it cut the fees it charges investors from 0.21% of assets to 0.19%, says Morningstar senior analyst Kathryn Spica.

“In general, the industry is improving” its offerings to investors, Spica adds.

You can invest in any state’s 529. In many states, however, you qualify for special tax breaks by investing in your home-state 529 plan. If you don’t, you should shop nationally, paying attention to fees and investment choices.

Morningstar raised Virginia’s inVEST plan, which offers investment options from Vanguard, American Funds and Aberdeen, from bronze to silver ratings, in part because Virginia cut its fees from 0.20% to 0.15% early this year.

Virginia’s CollegeAmerica plan continued as Morningstar’s top-rated option for those who pay a commission to buy a 529 plan through an adviser. American Funds, which manages the plan, announced in June it would waive some fees, such as set-up charges.

But there are exceptions. Morningstar downgraded two plans—South Dakota’s CollegeAccess 529 and Arizona’s Ivy Funds InvestEd 529 Plan—to “negative” because of South Dakota’s high fees and problems with Arizona’s fund managers.

Rhode Island’s two college savings plans moved off the negative list this year after the state started offering a new investment option based on Morningstar’s recommended portfolio of low-cost index funds. Given the potential conflict of interest, Morningstar did not rate the plans in 2014.

Joseph Hurley, founder of Savingforcollege.com, which also rates 529 plans, says he hasn’t analyzed the Morningstar-modeled funds because they are new and don’t have enough of a track record. But, he adds, the Rhode Island direct-sold 529 plan offers several low-cost index fund options.

Here are Morningstar’s top-rated 529 plans for 2014:

State Fund company Investment method Expenses (% of assets) for moderate age-based portfolio (ages 7 to 12) Five-year annualized return for moderate age-based portfolio (ages 7 to 12)
Alaska T. Rowe Price Active 0.88% 11.25%
Maryland T. Rowe Price Active 0.88% 11.42%
Nevada Vanguard Passive 0.19% 8.65%
Utah Vanguard Passive 0.22% 8.01%

Related:

 

 

 

MONEY bonds

Why Does Grandma Still Buy EE Savings Bonds?

granddaughter hugging grandma after graduating from college
Alamy

This popular investment pays much lower interest than people think and probably won't return much in time for college.

Last month I made a presentation to a bunch of high school students on the importance of basic financial planning skills. I had hopes of starting a conversation about saving for large purchases such a college education or a car. But the students were surprisingly interested in learning about EE savings bonds — those gifts that grandparents and other relatives give children to commemorate life events such as a birthday, first communion, or a Bar Mitzvah.

One student said he had savings bonds that were worth over $2,000. On special occasions, he said, his grandparents would give him a $50 EE savings bond. They told him that in eight years it would be worth $100 and then it would continue to double in value every eight years thereafter.

The Truth About Savings Bonds

Savings bonds that double in value every seven or eight years, however, have gone the way of encyclopedia salesmen, eight-track tapes, and rotary telephones. EE bonds sold from May 1, 2014 to October 31, 2014 will earn an interest rate of 0.50%, according to the US Treasury website. It’s not surprising that these interest rates are so low; what is surprising is that people are still buying these securities based on very old information.

You can buy EE savings bonds through banks and other financial institutions, or through the US Treasury’s TreasuryDirect website. The bonds, which are now issued in electronic form, are sold at half the face value; for instance, you pay $50 for a $100 bond. The interest rate at the time of purchase dictates when a bond will reach its face value.

This rate is detemined by discounting it against the 10 year Treasury Note rate, currently about 2.2%.

Years ago, you could calculate when your bond would reach face value by using a simple mathematical formula called the Rule of 72. If you simply divide an interest rate by 72 you can determine the number of years it will take for something to double in value. So, let’s try it. 72 divided by 0.5% = 144 years. Ouch!!

Fortunately, the Treasury has made a promise to double your investment in a EE savings bond in no less than 20 years. Actually it’s a balloon payment. So if you happen to cash out your EE bond in it’s 19th year, 350th day, you’ll only get the interest earned on the initial investment. You need to wait the full 20 years to get the face value. At that point, you’ve effectively gotten an annualized return of 3.5% on your initial investment.

So let’s recap. If Grandma wants to buy a EE savings bond for a grandchild to cash in to cover some college costs, she ought to buy that bond at the same time she’s pressuring her kids to start working on grandchildren. I joke, but, I think it’s very important to recognize the world has changed, and savings bonds don’t deliver the same solutions that many people remember from years past.

But back to the boy who stood up in class to talk about the savings bonds. What about the bonds his grandparents had purchased over the past several decades? Well many of those bonds may in fact be earning interest rates of 5% to 8%. It just depends on when they were purchased. The Treasury has a savings bond wizard that will calculate the value of your old paper bonds. Give it a shot. You may be pleasantly (or unpleasantly) surprised at the value of the bonds you have sitting around.

———-

Marc S. Freedman, CFP, is president and CEO of Freedman Financial in Peabody, Mass. He has been delivering financial planning advice to mass affluent Baby Boomers for more than two decades. He is the author of Retiring for the GENIUS, and he is host of “Dollars & Sense,” a weekly radio show on North Shore 104.9 in Beverly, Mass.

MONEY family money

This Company Will Give You $500 If You Have a Baby Today. Wait, What?

141017_FF_BabyMoney
Mike Kemp—Getty Images

It's no joke. As part of its rebranding campaign, investment firm Voya will give money to the newest of new parents.

Lucky for you if you’re in labor right now.

A company called Voya Financial has announced that it will give every baby born today—Monday, Oct. 20, 2014—500 bucks.

The promotion, timed to coincide with National Save for Retirement Week, is part of a marketing campaign to alert the public that the business that once was the U.S. division of ING is now a separate public company with a new name.

Get out the castor oil and order in Indian if you’ve already hit 40 weeks, because the offer is only available to those who exit the womb before midnight tonight—though soon-to-be-sleep-deprived new parents have until December 19 to register a child.

Voya estimates that it may have to kick in as much as $5 million, since there are about 10,000 babies born every day in the U.S.

While the company has promised that families will not have to sit through a marketing pitch to get the money, and that the baby’s information would be kept private, this special delivery still comes with a catch.

The money is automatically invested into Voya’s Global Target Payment Fund, which according to Morningstar has above-average costs and below-average performance.

Regarding the fees, Voya’s Chief Marketing Officer Ann Glover says that the funds Morningstar uses as comparison are not apples to apples. In any case, Glover says families are free to sell out of the fund if they so choose. “Of course, we would hope people would hold on to the investment,” she adds.

But hey, money is money, so if you’re due, you may as well take what you’re due.

And for those mamas and papas whose progenies aren’t quite ready to make their debuts? While you won’t get money from Voya, you may have other opportunities to get big bucks for your little one.

Start by checking in with your employer to see whether the company helps with college savings. A growing number do. Unum, for example, offers its workers with newborns $500 towards a college savings account.(Our Money 101 can help you find the best 529 college savings plan.)

Also, in several communities around the country, charitable or government programs seed savings accounts for kids. For example, residents of northern St. Louis County in Missouri can get $500 through the 24:1 Promise Accounts. Babies born in Connecticut get $100, plus $150 in matching funds by age four, thanks to the CHET Baby Scholars program.

“This is gaining significant momentum nationwide,” says Colleen Quint, who heads one of the nation’s most generous free savings program, the Harold Alfond College Challenge. Started by the founder of Dexter Shoes, the charity gives every resident newborn in Maine a $500 college savings account.

In fact, Mainers can get the most free money for their children according to a survey of such programs by the Corporate for Enterprise Development, which has gathered details on at least 29 free childrens’ savings programs.

Besides the $500 college savings account, a state agency will match 50¢ for every $1 parents contribute each year up to $100 a year and $1,000 over a child’s lifetime. So Mainers can, in theory at least, get up to $1,500 in free college savings money on top of any additional freebies they can get from companies.

That should be more than enough to buy a chemistry textbook in 2032.

MONEY Ask the Expert

Why You Might Want More Than One College Savings Account

Robert A. Di Ieso, Jr.

Q: I have college savings for my children in both education savings accounts (ESAs) and 529s. Is there a difference in the way those accounts are calculated for potential financial aid? Would there be any benefit to consolidating into one type of account? — Mike Spofford, Green Bay, Wisc.

A: The good news: There is no difference in how Coverdell ESAs and 529 savings plans factor into your child’s student aid, says Mark Kantrowitz, publisher of Edvisors.com, a website that helps people plan and pay for college.

Both of these education accounts are considered qualified tuition plans. So as long as they are owned by a student or a parent, the plans are reported as an asset on financial aid forms and have a minimal impact on your aid eligibility (federal aid will be reduced by no more than 5.64% of the value of the account). What’s more, your account distributions are not considered income, Kantrowitz adds.

Education savings accounts and 529s share other appealing features: Your savings grows tax-deferred and withdrawals are tax free as long as the money goes toward qualified education expenses. If you spend it on anything else, you will be hit by income taxes on the earnings as well as a 10% penalty.

One of the biggest differences is how much you can put in. ESA contributions max out at $2,000 per child per year, while 529s have no contribution limits. However, if you put more than $14,000 a year into your child’s 529—or $28,000 as a couple—the excess counts against your lifetime gift tax exclusion and must be reported to the IRS. You can get around that by using five-year tax averaging, which treats the gift as if it were made over the next five years.

Coverdell ESAs give you more investment options—from certificates of deposit to individual stocks and bonds to mutual funds and ETFs; you’re usually limited to a small number of mutual funds in a 529 plan. But you don’t need that much investing flexibility, Kantrowitz notes, since you want to keep risks and fees to a minimum over the short time you have to save for college.

Another key difference is that ESA funds can be spent on K-12 expenses; 529s must wait until college. ESAs also come with age restrictions. You can contribute only while the beneficiary is under 18, and to avoid penalties and taxes you must spend the funds by the beneficiary’s 30th birthday (with a 30-day grace period).

You can get around this age limit by changing the beneficiary to an under-18 close relative of the beneficiary. Or you can roll it over into a 529 plan with no tax penalty. (You cannot roll your 529 into a Coverdell ESA, however.) In fact, later-in-life education is one of the only reasons to consolidate plans. Otherwise, says Kantrowitz, there is no compelling reason to combine your two savings accounts into one.

MONEY Financial Planning

The One Time Raiding Your Kid’s College Savings Makes Sense

Broken money jar
Jeffrey Coolidge—Getty Images Normally, breaking into your college savings accounts is a no-no.

It's never a great idea, but in an emergency tapping funds earmarked for education beats sabotaging your retirement plans.

Lauren Greutman felt sick.

She and her husband Mark were about $40,000 in debt, and were having trouble paying their monthly bills. As recent homebuyers, the Syracuse, N.Y. couple were already underwater on their mortgage and getting by on one income as Lauren focused on being a stay-at-home mom.

“We were in a really bad financial position, and just didn’t have the money to make ends meet,” remembers Greutman, now 33 and a mom of four.

There was one pot of money just sitting there: their son’s college savings, about $6,500 at the time. That is when they had to make a tough decision.

“We had to pull money out of the account,” she says. “We thought long and hard about it and felt almost dishonest. But it was either leave it in there, or pay the mortgage and be able to eat.”

It is a quandary faced by parents in dire financial straits: Should you treat your kids’ college savings—often housed in so-called 529 plans—as a sacred lockbox, or as a ready source of funds that may be tapped when necessary.

Precise figures are not available, since those making 529-plan withdrawals do not have to tell administrators whether or not the funds are being used for qualified higher education expenses, according to the College Savings Plans Network. That is a matter between the account owner and the Internal Revenue Service.

TIAA-CREF, which administrates many 529 plans for states, estimates that between 10% to 20% of plan withdrawals are non-qualified and not being used for their intended purpose of covering educational expenses.

It is never a first option to draw college money down early, of course. Private four-year colleges cost an average of $30,094 in tuition and fees for 2013/14, according to the College Board. Since that number will presumably rise much more by the time your toddler graduates from high school, parents need to be stocking those financial cupboards rather than emptying them out.

Joe Hurley, founder of Savingforcollege.com, has a message for stressed-out parents: Don’t beat yourselves up about it.

“The plans were designed to give account owners flexible access to their funds,” Hurley says. “I imagine parents would feel some guilt. But I don’t think they should. After all, it is their money.”

Why the Alternative Might Be Worse

Keep in mind that there are often significant financial penalties involved. With non-qualified distributions from a 529 plan, in most cases you are looking at a 10% penalty on the earnings. Withdrawn earnings will also be treated as income on your tax return, and if you took a state tax deduction on the original investment, withdrawn contributions often count as income as well.

Not ideal, of course. But if your other option for emergency funds is to raid your own retirement accounts, tapping college savings is a last-ditch avenue to consider. That’s not only because you do not want to blow up your own nest egg, but because it could make relative sense tax-wise. And as the saying goes, you can borrow money for college, but not for retirement.

“If you think about it, a parent who has a choice between tapping the 529 and tapping a retirement account might be better off tapping the 529,” says James Kinney, a planner with Financial Pathway Advisors in Bridgewater, N.J.

If the account is comprised of 30% earnings, then only 30% would be subject to tax and penalty, Kinney explains. And that compares favorably to a premature distribution from a 401(k) or IRA, where 100% of the distribution will be subject to taxes plus a penalty.

Lauren Greutman’s story has a happy ending. She and her husband made a pledge to restock their son’s college savings as soon as they were financially able. It is a pledge they kept: Now eight-years-old, their son has a healthy $12,000 growing in his account.

She even runs a site about budgeting and frugal living at iamthatlady.com. Still, the wrenching decision to tap college savings certainly was not easy—especially since other family members had contributed to that account.

“We tried to take emotion out of it, even though we felt so bad,” Greutman says. “Since we didn’t have money for groceries at that point, we knew our family would understand.”

Related: 4 Reasons You Shouldn’t Be Saving for College Just Yet

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