Financial Q&A: Investing for College

Dear Deborah,

We have a daughter going to Virginia Tech in the fall. We live in Virginia. We have been told that our current $43,000 USAA investment portfolio is not properly allocated to provide funding for college expenses over the long-term. We are considering the VA 529 Invest Program. What should be our investment strategy? Which 529 Invest Fund should we choose for our daughters? (The younger daughter will start her junior year in high school this fall).

We also have $153,000 in the Federal Thrift Savings Plan.  Should I take a onetime withdrawal from the TSP when I turn 59 and a half next year? -- Michael

The USAA has a 529 college savings plan in a money market fund. As you may know, on the federal tax return, you don’t pay taxes on the interest if the money is used for higher education expenses. With the USAA fund, however, you won’t be able to take advantage of the VA state income tax breaks.

You may benefit more from the VA 529. In addition to tax-free earnings if used for education, you may deduct the $43,000 off of your income (in yearly increments, for eleven years) on your Virginia state income tax return. At the present time, by going with the VA 529 Invest Program, your residential state lets you subtract up to $4,000 a year from your taxable income (It is recommended that you check with your accountant for more detailed information).

Many money managers correctly advise that you should stay away from risking principal when you’re planning to spend the money soon. They suggest fixed income funds instead of stock funds, since there’s a risk of losing principal in equity funds.

When investing in fixed income or bond funds, also consider the possibility of losing some principal if, and when, interest rates go up, and the maturity time is not short-term.

An option is to invest in stable value or inflation-protected funds. Be aware, however, that you’re likely to have little positive return.

Distributions from parent-owned 529 college savings plans have a minimal effect on financial aid, since they’re in the parents’ names.

You mention you also have money in the Federal Thrift Savings Plan. It’s better to delay as long as possible and as late as possible the withdrawing of funds from the TSP. As you noted, there is a onetime withdrawal from this savings plan.

Remember, the more you can pay out of your family’s cash flow towards college expenses, the less you’ll need to borrow. Paying as much as possible out of one’s cash flow minimizes future debt.

Also, consider tuition installment plans offered by many colleges and universities. These plans allow the tuition bills to be divided into monthly payments of nine, ten, or twelve monthly payments. Generally there’s a flat fee to participate in the plan, usually ranging from $50 to $100. This is a good option for families who can spread out the payments during the college years.

Copyright 2013 Deborah Nayrocker. All rights reserved. Permission to reprint required.

Deborah Nayrocker writes on personal money management topics, showing others how to take control of their financial future. Deborah is the author of The Art of Debt-Free Living and Living a Balanced Financial Life.

Publication date: July 1, 2013