Look Beyond the 529 Plan for College Savings

DAN YU for the Wall St. Journal writes: Many people rely on 529 plans to save for college tuition, but they aren't always a one-stop solution.

I tell my clients it's best to start contributing to a 529 plan when children are very young in order to maximize the benefit of tax-free, compound growth. But by the time a child reaches his or her teens, 529 contributions make less of an impact. At that point it's usually wise to move to a more conservative asset allocation, which means slower growth. Also, there is less time for compound growth to be effective.

It is very possible that a client who puts away $10,000 a year starting when a child is born and earns 4% to 5% interest will have enough saved by the time the child turns 15 years old to pay for most or all of college.

But even if clients aren't sure they have saved enough by the time the child is 15, they should still stop contributing to the 529 plan because overfunding these plans can be costly. If the assets in the 529 plan aren't used up, the plan holder must pay a 10% penalty plus income tax on any earnings within the plan to gain access to the money.

At this point, I often advise clients to redirect 529 contributions to an investment savings account in their name. This account can be used to supplement a 529 plan, and any remaining funds can be used to supplement retirement income, penalty free.

Since not all of the money in the supplemental investment account is specifically set aside for college tuition, I can assume some of the assets have a longer time horizon to grow. That means I can set a more aggressive asset allocation and make up for any lost tax savings with higher returns.

In an ideal situation, a client would pay for his or her children's education using a combination of 529-plan savings, earned income and a supplemental investment savings account.

I believe it's also important that college students have some assets in their own name that they can use at their discretion for entertainment and other daily expenses not covered by tuition. Creating a Uniform Gift to Minors Account for children when they are young can be a great way to encourage them to start saving for themselves.

By the time they are ready to go to college, the account will transfer to their name. Even a few thousand dollars can really make a difference in the amount of financial independence they feel.

One final piece of advice: Advisers not working exclusively with high net-worth clients should always look into financial-aid and tax-credit opportunities that might lessen the burden of tuition for their clients.