5 Good Reasons NOT to Use a College Savings Account

5 Good Reasons NOT to Use a College Savings Account

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.

Maybe you’ve even read my posts describing the benefits of college savings accounts like 529 plans and Coverdell ESAs. Maybe you’ve even opened an account and started saving.

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The flip side is that all earnings can be withdrawn from the account tax-free if used for qualifying education purposes.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:

  1. How much you save. The more you save, the bigger the potential tax benefit.
  2. How early you start saving. The earlier you start (especially with big contributions), the bigger the potential tax benefit.
  3. 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:

  1. How much a college education will cost in 10+ years
  2. 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!

College savings accounts like 529 plans and Coverdell ESAs can be great in the right circumstances, and next week I’m going to give you five reasons why you SHOULD use them (stay tuned!).

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.

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8 Comments... Read them below or add one of your own
  • Hannah February 9, 2016

    One interesting piece of advice that I heard from some parents of a college sophomore and a high school junior is that they are treating college the same way that they treated daycare. They didn’t save up a ton of money for it, but it as an expense that needed to be paid.

    Interestingly, for their eldest son, the price for tuition (after scholarships) plus his share of a crappy apartment is less than I pay for daycare. When you think of it like that, it becomes much more manageable to consider helping kids pay for school in the future instead of right now. Of course, if we have more than two kids it could be tough to have such high expenses for a decade or more, but if its a priority, we’ll prioritize it.

    • Matt Becker February 9, 2016

      That’s a great example of an alternative way to pay for school. And a great comparison as well. There are of course no guarantees no matter which route you take, but I think it’s reasonable to expect that with some planning you could handle at least some of the cost in the same way that you handle your other bills.

  • Rachel February 9, 2016

    College savings is where I struggle the most since while we don’t have to divert retirement savings to fill up a 529 account, the money could be going towards paying off our mortgage early or a general investment account. Looking forward to Part 2 of this series.

    • Matt Becker February 9, 2016

      It’s not an easy decision and in many cases there is no “right” choice. All three options you’ve mentioned here sound like they would be positive, so it’s really a matter of choosing which one you think is most closely aligned with your personal goals.

      • Rachel February 9, 2016

        Thanks Matt. I’m still on the hunt for a crystal ball though!!

        • Matt Becker February 9, 2016

          Haha, the dirty secret is that it doesn’t exist! Beyond handling the basics (which it sounds like you’re doing), it’s a lot of personal choice. Sure, there are numbers to run and all of that. But past a certain point the numbers don’t mean a whole lot. It really comes down to enabling you to do the things you want to do with your life. The real secret is getting very clear about what it is you want to achieve and then making decisions based off of that. They don’t have to be the “best” decisions. They just have to be good enough to get you where you want to go.

  • Juanita March 15, 2017

    While we do have some savings in 529s for our 2 kids, we don’t save very regularly and have a different plan in mind.

    We refinanced to a 15-year fixed mortgage and plan to be mortgage free by the time our oldest is in college in 8 years. I’m starting to brush up my resume to reenter the workforce after being home w/the kids with the aim to pay extra toward our mortgage. For most people, housing is a big chunk of the monthly budget. It is for us! We realized that if we had no mortgage, we should have quite a bit to help pay for college.

    The first time we signed mortgage papers, our eyeballs almost popped out at the final pay off after 30 years. Yes, yes…tax deductible interest, but you’re still paying the bank a whole lot for the privilege of buying a home without all cash up front.

    • Matt Becker March 16, 2017

      This is a great strategy Juanita and one I often recommend. If you’re able to pay off your mortgage before your kids start school, that’s a huge amount of extra room in your budget that could be used for college tuition, or could be used for something else. It’s a great way to both get a guaranteed return on investment and create “savings” that has maximum flexibility.

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