This is the first post in a three-post series about giving money to children. This post will focus on college savings and, in particular, a 529 college savings plan. The next post will address other college savings strategies. The final post will discuss gifts that are not necessarily for education.

Over the past couple of weeks, I’ve found myself answering more than the usual number of questions about giving money to kids or grandkids. Primarily, the questions have focused on where is the best “place” to put money for little ones.

What’s crazy about this question is that there are so many potential answers that it actually gets a little mind numbing. From simple “mental accounting” — i.e., $X in this account is for Jr.’s college — to elaborate trusts and everything in between, the solutions are practically endless.

However, I do think there are a few strategies that won’t necessarily numb the mind and are certainly worth considering. The first thing to always ask yourself when this topic comes up is, “Do I want the child to use this money specifically and only for college?” If the answer is yes, then you should really focus on the tax benefits available when saving for college.

The current granddaddy of investing for college is the Section 529 College Savings Plan. Because of its popularity, I want to start here. But that doesn’t mean that I think this is necessarily the best place for college savings. Let’s explore what a 529 plan is and how it works.

The 529

529 plans are state-sponsored college savings plans that allow investors to save money on a tax-deferred basis. That means account owners are not taxed on dividends, interest, or capital gains they earn in the account. If investors use the money for qualified education expenses when distributing it from the account, they withdraw it tax free. Recent changes to tax law expanded the types of expenses that they can use 529 money for, which now include private K-12 education, for example. Still, limits exist on the types of investments allowed in a 529 plan. Mutual funds and bank products are typical of 529 plans, but there are rules on how often account owners can change those investments.

There is no federal tax benefit for contributing to a 529 plan. However, in the state of Colorado — and several other states — you can generally deduct your contribution for state income tax purposes if you contribute to a plan sponsored by the state. For the purposes of the Free Application for Federal Student Aid (FASFA), 529 plan assets are generally treated as the parent’s assets. This is important because, under the federal aid formula, the parent’s assets are viewed as “available” for college expenses at nearly 1/4 the rate of the student’s assets — 5.64% vs. 20%, respectively — and making them less “available” means potentially more available aid.

There is good and bad with a 529 plan. Probably the top gripe I hear is the availability of investment options. In the next post, we’ll explore some other options when saving for college, including some with a greater breadth of investment choices.