If you have children, chances are you’ve given at least some thought to saving for their college education. In fact, pretty much every new parent I talk to has it near the top of their list of financial priorities, so you wouldn’t be alone.
If you have, don’t worry. Saving for college certainly isn’t a bad decision.
But there are some good reasons to consider NOT using a college savings account, no matter how highly you value your children’s education. And in this post I’m going to give you five big ones.
Let’s get into it!
1. Other financial goals are more important
From a purely rational standpoint, college savings should be near the bottom of your list of financial priorities.
While saving for college is great, and if you have the money then by all means go ahead, the truth is that there are a LOT of routes to a college education. Here’s a short list of ways to pay for college without using a college savings account:
- Pay from your income, just like any other bill
- Apply for scholarships and grants
- Have your child work part-time while in school
- Take out student loans (not evil if you use them correctly)
- Attend a less expensive college
Meanwhile, other financial priorities like saving for financial independence, building an emergency fund, and buying insurance require you to either save or spend money now. Not doing so either makes the goal impossible or makes it much harder to achieve.
So before you start putting money into a college savings account, you’ll want to make sure that your other goals are on track. For more on exactly which goals to prioritize, check out this financial order of operations.
2. The tax benefits might be small
There is no federal tax deduction for contributions to a college savings account. And while some states allow a state income tax deduction for contributions to a 529 plan, many do not. If you live in one of the states that doesn’t, there is no immediate tax benefit for your contribution.
The flip side is that all earnings can be withdrawn from the account tax-free if used for qualifying education purposes. With a 529 plan, this means higher education costs only. With a Coverdell ESA, K-12 expenses can qualify as well.
That sounds great, but how big is that benefit really?
The answer depends on three main variables:
- How much you save. The more you save, the bigger the potential tax benefit.
- How early you start saving. The earlier you start (especially with big contributions), the bigger the potential tax benefit.
- Your investment return. The bigger the return, the bigger the potential tax benefit.
The problem is that most people have the least amount of money to save right when it would have the biggest impact. The best case scenario would be saving a large amount of money right when your child is born, but that’s just not realistic for most of us (myself included).
So let’s create a simple example and see how much money a college savings account would save you.
Let’s say that you save $100 per month from the time your child is born until the day your child starts college at age 19. That’s 19 years of saving, which means you will have contributed a total of $22,800.
Now let’s say that you were able to earn a 4% annual return on that money. That would give you a final balance of $34,181.
Subtract those two numbers and you have $11,381 in earnings (above what you contributed). This money would be taxed in a regular investment account, but would be tax-free in a college savings account.
So what’s the difference?
There is a wide range of possibilities in terms of what tax rate you would be subject to, but let’s keep it simple and say that it’s 15%. That means that if this money was in a taxable account, you would end up paying $1,707 in taxes upon withdrawal.
To put it the other way, you would have saved $1,707 by using a college savings account instead of a regular investment account.
Now, that’s not an insignificant amount of money. But it’s probably not life-changing either in the context of college costs. Just how significant it is depends on the specifics of your situation and the type of educational opportunities you are pursuing.
And the point here is simply that if you’re contributing a fairly typical amount of money to these college savings accounts, the tax breaks they provide aren’t likely to be as big as you might assume.
3. Who knows what education will look like in the future?
With the pace of change in education these days, there are two big things that are virtually impossible to know right now:
- How much a college education will cost in 10+ years
- What higher education will look like in 10+ years
Education in some form will obviously always be important. But with the advent of online learning platforms like Coursera, the number of universities opening up courses for free, and the number of tools and resources available for anyone to take what they learn and start a business, are you sure that the current college system will be the best route when your child is 18?
One of the problems with college savings accounts is that if you don’t use the money for qualified education expenses, your withdrawals will be taxed and subject to penalties. There is some flexibility there to use the money for other people (like yourself or grandchildren), but it’s still a risk given the uncertainty surrounding the future of education.
And don’t forget, you don’t HAVE to use a dedicated college savings account to save for college. Which brings us to…
4. You have other options
If you’d like to save money for your child’s future, whether that’s college or something else, one option is to use a regular investment account. You wouldn’t get any tax breaks, but remember that those may not be as big as you thought anyways.
And the upside is that you could use the money for anything at any time. What if your 14 year old daughter wants to start an online business? Or pursue a special education program overseas? That would be pretty cool, right?
Well if your money is in a 529 plan, it wouldn’t be available to help her (without taxes and penalties). But if it’s in a regular investment account, you can take it out at any time and support her initiative.
And an investment account isn’t your only option. You could also use a savings account. Or a Roth IRA.
These options all have drawbacks, sure. But they also provide more flexibility than a college savings account, which is a big advantage given that life can change pretty quickly.
5. Why not invest in your children now?
Joshua Sheats, a financial planner and all around money nerd, has an excellent podcast episode where explains all the reasons why he is choosing not to save for his child’s college education. And while I don’t agree with all of his points, it’s definitely worth a listen.
My favorite point that he made is that college is a short 4-year window in your child’s life. And if your child is young, it’s also many years away.
In the meantime, there are INFINITE opportunities to invest in your child right now and at other points along the way. You can help them explore their curiosities, have meaningful experiences, and learn skills they will carry with them for the rest of their lives.
Instead of dedicating all your free money to a small window of time many years in the future, why not use it to enrich their lives right now?
Of course, this doesn’t have to be either/or. You can certainly do some of each. But I think there’s a tendency to get so fixated on saving for college that we forget the opportunities we have to help our children now.
Man, college savings accounts are the WORST
Haha, now obviously that’s not true!
But the truth is that they’re not right for everyone or every situation. In a lot of cases it makes sense to put your money elsewhere first, and it may even make sense to avoid these college savings accounts altogether.
It wouldn’t make you a bad person. In fact, it might make you a really smart one.