When it comes to pursuing a successful career, education plays a vital role for many individuals. However, the cost of obtaining a bachelor’s degree can pose a significant financial challenge. Pursuing an advanced degree can further escalate the expenses involved. Families looking to finance their children’s higher education often explore options such as certificates of deposit (CDs) and 529 plans. But can the time-sensitive nature of CDs be harnessed to fund a state-run, tax-deferred 529 plan?
What Is a 529 Plan?
529 plans are tax-advantaged savings plans designed to assist with education costs. They come in two primary forms: savings plans and prepaid tuition plans. The program derives its name from Section 529 of the federal tax code, which addresses qualified tuition programs. Administered by each state, there are variations in rules and allowances among the 50 states and the District of Columbia. Funding options permitted in one state may not be recognized in another.
Primarily set up by older family members for child beneficiaries, a 529 plan accumulates funds on a tax-deferred basis until they are used for educational purposes. Withdrawals for qualified education expenses can be made tax-free at both state and federal levels. Expansion of the 529 program to cover K-12 expenses in 2017 and apprenticeship programs in 2019 broadened the scope of costs covered, with tax-free withdrawals capped at $10,000 annually for primary school payments.
Savings plans, one of the two types of 529 plans, allow account holders to invest in various mutual funds, including CDs. The account holder has control over how the funds are invested, with market conditions determining the growth or decline of the assets.
What Is a Certificate of Deposit?
A certificate of deposit (CD) is a time deposit account that generates interest over a specified duration. A prevalent offering at American financial institutions, CDs start with a fixed interest rate that accrues over the predetermined period. Upon maturity, the account owner can opt to renew the CD, transfer the funds to another account, or receive the funds themselves or designate a beneficiary.
Similar to 529 plans, each CD varies based on the issuing institution, rather than the state. With differences in terms and interest rates, individuals interested in opening a CD are advised to compare offerings before selecting an account.
Can You Fund a 529 Plan With a CD?
The possibility of using a CD to fund a 529 plan hinges on the available funding options within the specific 529 plan. While most 529 plans allow investment in approved mutual funds, some states offer CDs as a funding source for the plan, typically in partnership with local banks.
Irrespective of the state, these CDs function similarly to standard CDs, with users selecting the term length and deposit amount. If allowed to mature, the funds accrue interest along with the principal. Considered a low-risk investment choice for 529 plans, CDs offer a conservative approach compared to investing in the stock market.
Can You Fund 529 Plans With CDs in States That Don’t Offer the Option?
If a state does not provide CDs as an investment option, using a CD to finance a 529 plan becomes less feasible. Without the option to designate a CD for a 529 plan, individuals would need to wait for the CD to mature to access the funds or face early withdrawal penalties. In both scenarios, the outcome is akin to making a cash donation, without benefiting from the CD’s accrued interest.
Are CDs a Good Investment Option for a 529 Plan?
If permissible, a CD offers a conservative investment choice for a 529 college savings plan, primarily safeguarding the principal rather than fostering account growth. While many 529 plans feature target-date funds that transition investments from equities to fixed income securities as the target date nears, CDs, being the most conservative selection, must be separately purchased within the plan if permitted, as they are not part of mutual funds like target-date funds.
The Bottom Line
When considering funding a 529 plan with a CD, the feasibility is contingent upon state regulations. While certain states accommodate specialized CDs within 529 plans, others do not. In most instances, individuals may need to await CD maturity or reconcile with potential early withdrawal penalties.