Consider fees and availability of funds when deciding if a high-interest savings account should be part of your 529 plan.

Earn High Interest While Saving for College With 529 Plans

Savings accounts in 529 plans can offer higher interest than at the bank, but fees can affect earnings.

Consider fees and availability of funds when deciding if a high-interest savings account should be part of your 529 plan.
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Gary Bennett, a Virginia parent, earns more than double the interest rate on the savings accounts that are a part of his 529 plans, tax-advantaged college investment accounts, than he does from his bank.

Virginia offers a savings account in its state 529 plan with approximately a 2 percent interest rate. The national average for savings account interest rates was less than 0.1 percent for the week of February 8, according to the Federal Deposit Insurance Corp.

One reason 529 plan savings accounts and most individual savings accounts differ is the amount invested. Bank savings accounts with larger assets generally earn higher interest rates than savings accounts with smaller balances.

The combined assets from all investors—millions of dollars—in 529 plans allow a plan's officials to negotiate higher interest rates, says Lynne Ward, executive director of the Utah Educational Savings Plan (UESP). A parent who deposits $20 earns interest at the same rate as someone who deposited a total of $100,000. This isn't the case in the rest of the market, she says.

[Learn more about mistakes parents make saving for college.]

When considering savings accounts within 529 plans, parents should keep these three things about earning high interest rates in mind:

1. Many 529 plans offer both savings accounts and certificates of deposit, known as CDs. While CDs may have higher interest rates, money in high-yield savings accounts can be withdrawn at any time.

"The FDIC-insured savings account investment option offers account owners increased flexibility and freedom to contribute and withdraw funds according to their college savings needs," says Gilbert Johnson, president and chief executive officer of College Savings Bank, which manages 529 plans for multiple states. CDs, a safe but longer-term investment, have to be held for a set time period before they can be cashed in without an early-withdrawal penalty.

2. Investment fees might be charged, which could lower an account's earnings. These fees can be charged on investments in any kind of account or mutual fund. Within the Utah Education Savings Plan, the current annual interest rate is 0.67 percent. However, plan participants pay 0.15 percent in investment fees. That means parents earn 0.52 percent on deposits.

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The College Savings Bank plan doesn't charge an investment fee for its Honors Savings Account and offers a 0.70 percent interest rate. Since investment fees vary, parents should always ask, experts say.

3. When comparing interest rates, parents should consider state tax deductions and credits. These benefits can significantly raise the earnings parents can pocket for their child's education, Ward says.

If parents consider state tax credits, they can earn nearly 10 times more than the 0.52 effective interest rate (after deducting investment charges) on UESP savings—total earnings of more than 5 percent.

[Find out how to pay cash for college.]

Here's an example: If a family of four with an adjusted gross income of approximately $50,000 deposited $100 per month into a high-interest account in 2012, they would have accumulated $1,200 before any interest. With an interest rate of 0.52 percent, the account would earn $3.38.

The family would gain another $1 because the $3.38 earned wasn't taxed federally like it would have been if it was earned on a savings account outside of a 529 plan. Then for Utah taxpayers, the state income tax credit for USEP accounts adds another $60 (5 percent). The result is $64.38 earned instead of $3.38 for that year.

"The No. 1 reason I invested in a 529 plan is that I can write off up to $4,000," says Bennett, the Virginia parent. "It was an immediate tax advantage."

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