Every dollar saved for college, whether in a 529 plan or other type of account, is one dollar less that a child will have to borrow in student loans. In recent years, high-yield savings accounts have become popular due to their convenience and relatively high interest rates compared to traditional savings accounts. But, high-yield savings accounts may not always be the best way to save for college.
Here are some things parents should keep in mind when considering a high-yield savings account for college savings.
What is a high-yield savings account?
A high-yield savings account is a bank account that offers a higher interest rate than a traditional savings account. Interest rates on high-yield savings accounts typically range from 1% to 2%. Many banks and credit unions offer high-yield savings accounts, but online banks typically offer the best rates.
In most cases, an investment account such as a 529 plan is a better college savings vehicle for families. However, families who are risk averse or who have a short time horizon may benefit from the guaranteed returns offered by a high-yield savings account.
Advantages of using a high-yield savings account for college savings
- Opportunity to earn more. A traditional savings account may only yield .01%, but interest rates on high yield savings accounts can be 2.0% or higher.
- High-yield savings accounts are safe. High-yield savings accounts that are opened at an FDIC insured bank or credit union are federally insured up to $200,000.
- High-yield savings accounts are convenient. Most high-yield savings accounts can be opened and managed online.
- Accounts are flexible. You can withdraw funds from a high-yield savings account for any reason. If you decide to use the money for something other than college expenses, you will not be penalized.
- High-yield savings accounts are not exposed to market risk. In most cases, returns are guaranteed, and you will never lose your principal investment.
Disadvantages of using a high-yield savings account for college savings
- Lower rate of return. With low risk comes low potential reward. Parents may be able to earn more for college in an investment account, such as a 529 plan.
- Taxable interest. Interest earned on a high-yield savings account is included in the account owner’s gross income.
- Less of an incentive to use the funds for college. High-yield savings are very liquid, which could tempt some parents to spend the funds on other priorities before their child enters college.
- Forgoing a potential state tax benefit. Over 30 states offer a state income tax deduction or state income tax credit for 529 plan contributions. State income tax breaks are not available when parents use a high-yield savings account to save for college.
- Financial aid implications. Parent-owned high-yield savings accounts have a relatively minimal impact on a student’s financial aid eligibility. But, high-yield savings accounts owned by a student can reduce the student’s financial aid eligibility by 20% of the account value.
How to open a high-yield savings account
Most high-yield savings accounts can be opened online. But with so many different options available you’ll want to do your research when selecting a high-yield savings account. In addition to comparing interest rates offered by different banks, it’s also important to consider fees. The more you pay in fees, the less you will be able to save for college. Consider the net return on investment, after subtracting the fees. Parents should try to avoid banks that have minimum monthly balance requirements, high monthly maintenance fees or other fees.
You’ll also want to know how you can access your money when you need it. Can your existing bank and brokerage accounts be linked to the high-yield savings account? Having access to ATMs might not be necessary when initially using a high-yield savings account to save for college, but it might be something you’ll want in the future. For example, you may want to give your child access to the account when they are in college to pay for textbooks or groceries. If this is the case, you might want to consider a bank that offers free ATMs nationwide.