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By Christine Benz and Adam Zoll | 04-17-2014 11:00 AM

More Prep Needed for College-Planning Test

Debt is rising, the SAT is changing, top-school acceptance rates are dwindling, and a large disconnect remains between household college savings and total costs.

Christine Benz: I'm Christine Benz for Morningstar.com. Average college-savings account balances were up nicely in 2013 from the year before. Joining me to discuss this and other news in the realm of college funding is Adam Zoll. He is assistant site editor for Morningstar.com

Adam, thank you so much for being here.

Adam Zoll: Thanks for having me.

Benz: Sallie Mae does this study annually looking at how people are saving for college and how much they've saved. You say that the most recent survey actually shows some pretty encouraging trends.

Zoll: There are some encouraging trends in terms of the amount saved. First of all, the survey found that about half of all parents with children ages 0 to 18 are saving for college. That's held steady since the previous year, but the balances are up about 30%. First of all, the amount that people on average are contributing to college savings averages about $3,400 per family. That's up about 30% from the year previous. And the overall balance, which stands about $15,300, is also up about 30%.

We're coming off a year with very strong stock gains; that probably played a role. But in general people are contributing more to college savings which is a positive development. Again $15,000 is not even going to pay for one-year of undergraduate education at an in-state public school, but at least people are focused on saving more for college.

But again, there's a real shortfall, a disconnect between what they're going to need and how much they are saving at this point.

Benz: Families still have some work to do. The survey actually unpacks where people are saving for college. You think that it's pretty interesting when you look at what vehicles people are using for their college savings. You think they could make better choices.

Zoll: Absolutely. The most commonly used vehicle to save for college is a general savings account. And anybody who has a savings account in a bank knows this is an account that's paying you right now probably less than 1%. When you talk about college savings, saving for a goal that may be 10 or even 18 years away, you really want to give your assets a chance to grow. The best way to do that is to expose them to stocks.

One of the problems with saving in a general savings account is you're really not giving your money much of a chance to grow. You're gaining the ability to withdraw that money if you should need it for an emergency for some other purpose. That's great to have that flexibility, but you are also not really allowing that asset to grow.

Another advantage that you're depriving yourself of is the tax advantages of accounts like a 529 college-savings plan, a Coverdell Education Savings Accounts, and even a custodial account. These are tax-advantaged savings vehicles that can allow your money to grow for college without having to pay taxes each year, and then when you take those distributions to use to pay for college, you're not paying any taxes. If you invest in a taxable account and put the money in stocks, those embedded capital gains are going to hit you with a tax bill.

The most efficient way to save for college is through one of these tax-advantaged accounts. You are sacrificing the flexibility of withdrawing the money if any emergency should arise, but you are gaining the potential to have a lot more saved up for college when you need it.

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