My daughter’s first birthday is fast approaching, but I’m already thinking way ahead.

It’s been a whirlwind of a year, and in my limited quiet time I like to hunker down and make sure we are on track when it comes the future for her and her two brothers.

The planner in me is already looking out 17 years to college.

I have no idea what college will look like in 2038. No one does.

Here are some guesses:

  • It still involves in-class learning and costs a fortune.
  • It’s all online and still costs a fortune.
  • The entire system collapses under its own weight.
  • Or maybe the government nationalizes it.

No one knows. But it makes sense to plan.

If you’re disciplined and sock away money for college that you end up not needing, your biggest problem will be finding a new place to spend it.

So let’s jump into it.

The most popular way to save for college is via 529 savings plans, which look and feel like a 401(k).

Most plans have a menu of mutual funds or target-date funds to choose from. And they’re easy to administer. I have 529 plans for all three of my kids.

Should You Save in a 529 Plan?

The short answer is, “yes.”

The longer answer is a bit more nuanced.

If you have excess cash on hand, by all means, you should open a 529 college savings plan. It’s best if your kid is young. A 529 plan is similar to a Roth IRA or Roth 401(k) because there is no immediate tax break for the contribution. But all capital gains, dividends and interest grow tax-free and enjoy tax-free withdrawals — as long as you use your withdrawals for qualified educational expenses.

The younger your child, the more that tax-free compounding matters because time is on your side. A 529 makes the most sense if you plan to save in those first 5-10 years of life.

If your kid is already a teenager and starts college in a couple of years, there’s not a lot of value in stuffing the cash into a 529 plan. You’re just going to take it out again in short order. There’s not enough time for the tax-free compounding to work its magic.

But let’s say you start early. Even then, I’d argue that a 529 plan only makes sense if you’re already maxing out your 401(k) or other retirement plan.

Max Retirement Before College Savings Plans

Here’s why…

Your 401(k) plan gives you an immediate tax break. That’s more cash today to invest and compound. If you start saving early, you won’t need to save as aggressively later in life.

By the time your kids are in college, you may be at the peak of your career, earning more money than you were when they were born. (I’m quietly sobbing to myself at the realization that I’ll be old enough for early Social Security benefits by the time my daughter goes to college…)

At that stage of life, you’ll be in a better position to help them out of your current cash flows. They would also have access to student loans, which you could help them pay back if you wanted.

Furthermore, you can raid your retirement funds for educational expenses if you need to.

Under current tax rules, you can take penalty-free distributions from an IRA or Roth IRA to pay for educational expenses.

You can’t take funds from a 401(k) plan directly, but you can roll over your 401(k) into an IRA and then take a penalty-free distribution for college expenses. It’s not my first choice, but it’s an option if you need it.

The point is: You have to take care of yourself before you can take care of your children.

You’re not doing them any favors sacrificing your retirement savings in order to boost their college fund if they end up having to support you in old age.

So, again, you should contribute to a 529 college savings plan if you have the cash flows to do it. But max out your 401(k) plan first.

To safe profits,

Charles Sizemore_Sig

Charles Sizemore

Editor, Green Zone Fortunes

Charles Sizemore is the editor of Green Zone Fortunes and specializes in income and retirement topics. Charles is a regular on The Bull & The Bear podcast. He is also a frequent guest on CNBC, Bloomberg and Fox Business.

Story updated on July 12, 2021.