How to make 'Lazy Money' start working to save for college

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Many families are badly prepared on the college savings front, finding it very hard to make ends meet, let alone save for college. Yet more often than not, these families are unaware of the helpful tools and techniques available. In fact, two-thirds of Americans don't even know what a 529 plan is, according to a recent Edward Jones survey.

So, if you, as a trusted advisor, can educate these clients as to how a 529 plan is typically the best place to start when saving for college - it can help open the door to other cross-selling opportunities, deepen client trust and therefore improve overall client-satisfaction and retention levels.

One potential idea, especially in the mass affluent marketplace, is to identify so-called 'lazy money' deposits in parent or grandparent accounts, and recommend repositioning those resources to shore up a college savings gap.

A lot of money has become 'lazy money' in recent years - i.e., large deposits (think $300-500k) just sitting there, lethargically 'on the sidelines' making a paltry, say 80 bps to 1% a year in low interest rate, non-qualified, taxable bank, CD or Money Market type accounts.

What clients often fail to realize is that in real terms, they are not keeping up with the real inflation rate, and that this 'lazy' money could be repositioned into a higher earning retirement or college savings account, or both, depending on their particular needs, circumstances and goals.

It may be helpful to recommend a 529 plan or other college saving strategy, as one potential way to allow these clients keep control of their money while making it work harder in a tax-advantaged and flexible way.

RELATED: 75% of college savers don't know how to invest their 529 savings

Without going into excessive detail or analysis, here are three possible college savings options to consider:

1. Low-risk 529 plans

Unlike non-qualified accounts (i.e., non tax-sheltered accounts), 529 plans offer compounded tax-advantaged returns, and tax-free withdrawals when they are used to pay for qualified education expenses. And if your client's circumstances change, they can take back the money at any time for non-college funding purposes. However, unless the beneficiary dies, becomes disabled, attends a U.S. Military Academy or gets a scholarship, they will incur taxes and a 10% penalty on the earnings portion of all non-qualified withdrawals. The principal can always be withdrawn penalty-free.

For parents and grandparents who aren't comfortable with taking on market risk, or who have kids approaching college age, certain 529 plans have certificate of deposit ("CD") options that have historically delivered strong risk-adjusted returns.

For example, College Savings Bank offers three CD options, with maturities ranging from 1 to 22 years, in addition to a high yield savings option. One option, the InvestorSure CD, (offered through the Arizona, Montana and Indiana 529 plans and available to residents of any state) delivered an annual percentage yield of 6.82% over the last 5 years. This is streets ahead of regular, (and lower yielding) plain vanilla bank CD's which are taxed every year on their earnings.

What's more, over a dozen states are now offering FDIC insured bank products in their 529 programs. These options may be especially attractive for risk-averse clients who prefer 'guaranteed' instruments that protect their principal yet lock in the lucrative 529 tax benefits available. Another example, albeit without a CD option, is Virginia's CollegeWealth, which offers bank savings programs through BB&T and Union Bank and Trust.

However, one caveat for these Federal Deposit Insurance Corporations ("FDIC") insured 529 accounts is that any amount over $250,000 is not backed by the full faith and credit of the US government guarantee. Hence, for even more peace of mind, it may help if each account is kept under the $250,000 threshold.

Finally, depending on where your client resides, make sure to leverage any and all state tax deductions or credits that are available to residents of any given state - just as you would do for a non-FDIC insured type 529 plan. Bear in mind that 45% of the U.S. population live in states that offer their residents additional state-specific tax benefits for investing within their own state's 529 plan while 10% of the population live so-called tax-parity states, wherein residents enjoy a state tax benefit regardless of which 529 plan they use.

RELATED: 12 states offering FDIC insured 529 plan options

2. Market-based 529 plans

Families who have younger children and are looking for investments that can appreciate more aggressively over time and hopefully outpace college price inflation (albeit subject to market risk) also have a wide range of 529 savings account options to consider - accounts that again, compound without the drag of taxes and blossom tax-free when used for qualified educational expenses. These accounts, generally managed by large reputable investment management firms like Vanguard, Fidelity, American Funds and TIAA-CREF can include:

a. a wide array of static portfolios: most typically invested in equity and/or bond mutual funds or ETFs, but which also offer many more esoteric investment options like REITs, international equity, international bonds, small cap funds, and a mix of low load passive or active strategies to choose from.

A recent trend in the evolution of the 529 industry has been a major swing towards lower cost investment options, mainly in the form of indexed-based portfolios. Vanguard, as always, has been to the fore in this regard and has many fine offerings to choose from across various states in both direct-sold and advisor-sold 529 plans.

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b. age-based (target date) portfolios that have an in-built glide-path that will shift toward a more conservative investment allocation as the beneficiary gets closer to college. These types of platforms attract the lion's share of 529 assets these days, however not all target date plans are alike and vary considerably in their asset allocation and glide path methodology. Moreover, they are not immune from major downside market risk. Some equity heavy funds dropped by as much as 40% during the 2008 crisis so one needs to choose these funds prudently.

RELATED: Compare 529 plans by features

3. Insurance products

Lastly, for those who are comfortable looking further afield than 529 products, there are some non-traditional insurance-based products like life insurance, annuities and low cost modified endowment contracts (or hybrids thereof) that offer security, meaningful growth with zero downside risk to account value, as well as full 100% liquidity.

These new indexed type products come in many flavors and with differing cost structures, so one needs to be careful and shop around intelligently. However some of these products, those with waiver of surrender charge and appropriately structured low cost riders, can be tailored for many uses, including tax-advantaged college savings (albeit, 529 plans are generally a better option).

These instruments may be of interest to certain clients looking for 'outside-the-box' college and retirement savings solutions, but a thorough examination of how they might be used is beyond the scope of this article.

RELATED: A shortcut to comparing 529 plan investment options

All of the foregoing general ideas however, are predicated on a foundation of prudent and holistic financial planning. We are assuming for example, that each client would have enough liquidity set aside for a meaningful 'emergency fund', and that he or she has not allowed a college savings fund to completely trump the arguably more important priority of saving for retirement.

Each client's situation is different and accordingly, one needs to look closely at estate planning, gift tax, and financial aid consequences of any college saving game plan.