We get a lot of questions from parents about using mutual funds to save for college. The truth is that mutual funds aren’t always the best way to save for your child’s education. And there are a few reasons why.
What is a mutual fund?
A mutual fund is essentially a way for you to diversify your portfolio. It pools money from investors to purchase a variety of bonds, stocks, and other investment assets. Typically, you’ll have a fund manager that oversees your investment and directs purchases through your portfolio.
They’re not as easy as something like a 529 Savings Plan, where you either work with a financial planner or oversee things on your own. But here are some other reasons why a mutual fund isn’t always beneficial to your college savings plan.
The Tax Situation
Unfortunately, mutual funds are subject to capital gains distribution at the end of the year. That’s whether you want the gains or not. Whereas something like a college savings plan doesn’t get taxed unless you make an unqualified expense withdrawal.
Additionally, you’re taxed the appreciation of the fund when you decide to liquidate— say for something like your college education. Plus, for high-income earners, there’s a surtax that might apply to you.
The Financial Aid Situation
Unlike the 529 Savings Plan, which doesn’t count as assets on the Free Application for Federal Financial Aid (FAFSA®), a mutual fund does. Depending on the number of capital gains you have in the fund, it could mean that your child qualifies for less need-based financial aid.
This could be a major problem for low-income families that tried to invest in college but put a dent in the free aid available to them.
Individuals who invest in mutual funds are typically open to high-risk investments. When it comes to college savings, that isn’t always the best idea.
In fact, financial advisors tell parents to start pulling back on risky investments the closer their child nears college. With a mutual fund, parents could end up taxed on built-up gains when they try to move funds to a safer allocation.
Making investments to save for your child’s future is a big decision. It’s best to talk to a financial advisor and be directed to an option that will work best for you.
You can learn more about college savings plans right here on Frank. Reach out to us directly or take a look through our informative How to Pay for College resource.