A 401(k) is not a college savings plan
Oct 6th 2010 1:00PM
Updated Jan 26th 2011 10:41PM
Here's the good news: Families are saving for college. In fact, according to a study released earlier this week by Gallup and Sallie Mae, 60% of families are socking money away. And they're doing a pretty good job of it. They start, on average, just after their child turns 3, and save about $3,000 a year. Gallup estimates these families will have about $48,000 by the time those toddlers matriculate, enough to fund about two years worth of education at the average four-year public college or university.
Here's the bad news: Much of the money that is being "saved for college" is being socked into 401(k) retirement accounts. To access it come college time, parents say they'll borrow or withdraw money from those plans, as a full 24% of parents are today. Neither are particularly good options. Borrowing from a 401(k) costs you future growth on that money as well as interest; plus if you lose your job you can be required to pay the money back inside 60 days or face income taxes and penalties. Withdrawing is worse. Taxes and a 10% pre-retirement penalty can cost you 30 to 40 cents on every dollar. Plus, because any money you withdraw is treated as income, you can lose financial-aid eligibility for the following year.
That's not the only mistake parents are making. The Gallup researchers also noted that although the percentage of low-income families (earning below $35,000 a year) saving is actually higher than the percentage of families earning significantly more. Those families tend to save in their checking or savings accounts. By not making use of 529 accounts or other college savings vehicles, they miss out on tax-free growth as well as state tax deductions or other benefits.
Programs like the K2C – Kindergarten to College initiative -- announced by San Francisco yesterday should help. K2C will open a $50 college savings account for 1,200 children entering kindergarten in the city's public schools (18 schools are piloting the program). Parents, friends, employers (whomever) will be able to contribute to these accounts, which are being administered by Citibank. Once the balance reaches $100, EARN, the leading provider of matched savings accounts for low-income workers, and the program's not-for-profit sponsor, will match the $100 -- bringing the balance to $200.
Ben Mangan, CEO of EARN explains that they've found that setting up these accounts changes awareness in terms of college saving in general. "There have been studies that children with college matched-savings accounts turn out to be seven times more likely to go to college," he says. The results of the Gallup and Sallie Mae study concur. It dug into factors that motivate parents to save for college and matching dollars were high on the list. Unfortunately, in this economy, programs like this one may be tough to replicate. But what's also needed is more and better education about the benefits that already exist. When asked why they don't save for college, 18 percent of survey respondents answered: "I don't know how."