Saving for college? Why bank accounts aren't smart

September 27, 2016 10:13 PM EDT

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By Beth Pinsker

NEW YORK (Reuters) - Parents, particularly those under 35, are increasingly confident they can afford college for their children, but underlying that optimism is a hint of caution. A new survey from student loan lender Sallie Mae warns that if economic growth does not keep up with inflation, then they may not have enough despite their best intentions.

The latest “How America Saves for College” report, released by Sallie Mae on Thursday, finds that the number of parents saving for college jumped to 57 percent, from 48 percent last year. The average amount saved is now $16,380, up from $10,040 in 2015 and $15,346 in 2014.

The survey found 55 percent of parents thought they could afford college for their children, up from 42 percent in 2015. When millennial parents were asked that figure jumped to 65 percent.

College saving dollars are going into a myriad of accounts as families take a multi-pronged approach to saving. Tuition is something of a moving target, with a 5 percent historical average inflation rate according to The College Board, and hard to predict many years out.

A majority of families - 61 percent - are saving in general savings accounts, according to Sallie Mae, while 38 percent are using checking accounts. Most are likely earning 1 percent or less in interest that way.

They are also at risk for spending co-mingled funds on emergencies or other temptations. Only 37 percent report having a 529 college savings plan, which grows tax-free if the money is used for education. That is up from 27 percent in 2015.

This data is borne out by other recent studies, such as Fidelity's August report(see http://www.reuters.com/article/us-education-university-investment-idUSKCN1100A6).

KEEPING UP

Financial planners worry that trying to build a college fund in a bank account makes about as much sense as simply stashing it under a mattress.

“A dollar today is not buying a dollar in the future,” warns Karen McIntyre, managing director and senior financial advisor at Wescott Financial, based near Philadelphia, Pennsylvania.

For families with a child who is a junior or senior in high school, cash accounts might make some sense, says Larry Rosenthal, a financial planner with his own firm in northern Virginia. But for anyone with a longer time horizon, there are better options - and not every one is as risky as putting it all on a single stock.

“There's a lot of places in between where you can have less risk and garner a little return,” Rosenthal says, pointing to laddered bond scenarios or bond funds. He has also seen grandparents who are older than 59-1/2 withdraw from Roth IRAs without penalty to gift money.

The reason many financial pros point to 529 college savings accounts is because of tax advantages. At first, it may not seem like much. Parents putting in $100 a month might reap about $40 a year in a state tax deduction, says McIntyre, which in Pennsylvania is about 3 percent. But as you get closer to college and ramp up savings, the savings go up.

For instance, if you roll $28,000 in freshman year tuition into a 529 just before paying the bill, you would save about $850, she says.

Investing money all along in a 529 has additional benefits because the accounts grow tax-free. In contrast, a cash account might lose ground relative to the general inflation rate, and a brokerage account will incur taxes on growth all along, and then capital gains tax when you sell the holdings to pay tuition.

Perhaps the biggest benefit of all to 529 plans is that research shows they encourage families to save more. Sallie Mae’s survey found that the savings rates of families with 529 plans was higher than those without. The average account balance in a 529 is $7,534, versus $7448 for an investment account and $6,043 in a savings account.

“There is still a lack of awareness for 529 that hamstrings families when they think about saving for college,” says Sallie Mae spokesman Rick Castellano. “I think it is encouraging that more people are saving and that they are saving more money. But how do you make that money work harder for you? How do you do it even smarter?”

One way that is increasing in popularity is auto-deductions from payroll directly to 529 accounts. George DuCasse, senior vice president of 529 plan administrator Ascensus College Savings, says they now work with about 7,000 employers across the country, a number that goes up about 10 percent a year.

In 2014, when there was a market downturn, 529 contributions dropped from families who wrote a check once a year, but among those whose payments were automatic, there was actually growth, DuCasse notes.

(Editing by Lauren Young and Andrew Hay)



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