Earning an education is one of the biggest motivators toward a successful career for many people, but earning a bachelor's degree can be an expensive proposition. Need an advanced degree and you could be faced with an even bigger price tag. As families try to prepare the funds necessary to get their kids through higher education, options like certificates of deposit (CDs) and 529 plans are seen as potential methods of funding a child's post-secondary education. But can you use the time-sensitive nature of CDs to fund a state-run, tax-deferred 529 plan?
- Whether you can use a CD to fund a 529 plan depends on if the former is listed in the plan's available fund options.
- Some banks offer specialty CDs that work directly with a 529 plan.
- Without specialized CDs or being approved as a fund option, you will have to either wait for the CD to mature or withdraw the funds early to invest into a 529 plan.
What Is a 529 Plan?
Created to help pay education costs, 529 plans are tax-advantaged savings plans that come in two forms: savings plans and prepaid tuition plans. This program gets its name from Section 529 of the federal tax code, which deals with qualified tuition programs. Run by each of the 50 states and the District of Columbia, each state has its own set of rules and allowances. What may be allowed for funding in one state may be completely omitted from the approved list of sources in another.
Typically opened for child beneficiaries by older family members, a 529 plan grows over time on a tax-deferred basis until the funds are used to pay for educational purposes. As long as the money is spent on qualified education expenses, the withdrawals can be made tax free at the state and federal level. The types of costs covered by the 529 program grew when it was expanded to cover K-12 costs in 2017 and apprenticeship programs in 2019, though tax-free withdrawals are limited to $10,000 per year for primary school payments.
When it comes to the two types of 529 plans, savings plans allow the account holder to invest money into a selection of mutual funds, which could include a CD. The account holder chooses how the money is invested and market forces will determine whether the funds grow or diminish over time.
Only a small list of states offer the prepaid tuition plan. Generally, they allow you to lock in tuition costs at the current rates, rather than wait to deal with perpetually growing tuition rates. This plan also increases in value over time and withdrawals for tuition payments are non-taxable.
What Is a Certificate of Deposit?
A certificate of deposit, or CD, is a time deposit account that gains interest over time. As one of the more ubiquitous offerings at American banks and credit unions, CDs start with a fixed interest rate that the bank pays the into the CD over a set amount of time. As long as the funds deposited in a CD is left undisturbed until it reaches maturity, which could take months or years. Once the term is over, the account owner can choose to either roll over the CD into a new one, transfer it into a different bank account, or opt to receive the funds themselves or give them to a beneficiary.
Much like a 529 plan, each CD is unique, though the differences are based on the bank or credit union selling the CD, not the state. With varying terms and interest rates, it is then best for anyone interested in opening a CD to do some shopping around before opening an account.
Can You Fund a 529 Plan With a CD?
When it comes to whether you can fund a 529 plan with a CD, the answer depends on the funding options available to you for that 529 plan. While nearly every 529 plan will let account holders invest, either aggressively or conservatively, in a list of approved mutual funds, some states offer CDs to help fund the plan. According to FINRA, states that do that offer CDs "whose interest rates are linked to an index that measures the average cost of college tuition." These CDs are provided by local banks and in some cases are done in collaboration with the state.
Regardless, these CDs operate just like any other, with users choosing a set term length and deposit amount. As long as those funds are allowed to mature, those funds will accrue interest that will be paid out along with the principal. Considered a very conservative investment option for 529 plans, there's significantly less risk in it than choosing an investment portfolio and leaving those funds to the whims of the stock market.
Can You Fund 529 Plans With CDs in States That Don't Offer the Option?
Even though the option is available in only some states, that doesn't mean you can't necessarily use a CD to fund a 529. It's just going to be a less-than-ideal option. In states that don't offer CDs as an investment option, you can't designate one for a 529. That's because CDs typically need to be attached to a recipient, whether that's the person who took out the account or a beneficiary.
If you want to use the money in a CD to help fund a 529 plan, you're either going to have to wait for it to reach its maturity date and receive the money that way, or withdraw funds early and suffer any associated penalties. In either situation, you're effectively just making a cash donation, so it won't benefit from the interest rates that a CD accrues over time.
Are CDs a Good Investment Option for a 529 Plan?
If allowed, a CD would be a very conservative option for a 529 college savings plan that would largely just preserve the investment principal rather than growing the value of the account. Many 529 plans offer target date funds that shift investments from equities toward fixed income securities as the target date approaches. Certificates of deposit, which would be the most conservative of investment choices, are not offered within mutual funds like target date funds and must be purchased separately within the 529 plan, if allowed.
The Bottom Line
If you want to fund a 529 plan with a CD, there are options but they're heavily dependent on your state's rules. While some states allow 529 plan holders to invest specialized CDs into their funds, others do not. In most cases, you're either going to have to wait for the CD to mature or you'll have to accept that some early withdrawal penalties are in your future.