Paying for College: Will Your Planning Make the Grade?
By Angela Park Sheldon
(Alpha Psi chapter, University of California-Los Angeles)
Kids grow up too fast, so treasure every moment.” If I had a dollar for every time someone gave me that advice, I might have enough money to send my kid to college! Some might assume it’s premature for me to be thinking about paying for college when my child is only an infant, but it is absolutely necessary if you are planning on paying for some, if not all, of your child’s college education costs.
Friends of mine remember when college tuition costs were about $4,500 per year, while others recall paying only several hundred dollars a semester! For the 2009-2010 school year, the average cost of tuition and room and board was $12,804 per year at a public institution, and $31,023 per year at a private institution. Therefore, if your child is in college now, you will spend around $51,216 over the course of four years at a public institution. If your child is born today and won’t be entering college for another 18 years, the cost climbs to $230,555, once adjusted for inflation of 8 percent. Even though the Consumer Price Index (CPI) estimates general inflation has averaged between 3 and 4 percent every year, college education expenses have increased by roughly twice that amount.
The thought of saving $230,555 is daunting, especially considering other financial responsibilities such as planning for retirement, paying medical expenses, buying a house, caring for elderly parents and even paying for other children to attend college. Short of a scholarship or a grant, how do you pay for such an exorbitant expense? This is where planning early makes a big difference.
Fortunately, there are special savings vehicles designed specifically for higher education expenses such as the Coverdell Education Savings Account (ESA) and the 529 plan. The Coverdell ESA allows annual contributions of $2,000, and there are income restrictions for those earning a modified adjusted gross income (MAGI) above $110,000 as an individual, or $220,000 as married filing jointly. The 529 plan, on the other hand, has no income restrictions, and the lifetime contribution maximums are over $300,000 in most states. Considering that four years at a public university is expected to cost over $200,000, the 529 plan would allow you to save the amount needed to cover the costs.
The 529 plan is a tax-deferred account, meaning you do not receive a 1099 tax form until you start taking distributions. There are no taxes due on this account every year, even if there are gains in it. The distributions also come out tax free as long as they are being used for qualified higher education expenses such as tuition, room and board, and books. If you take an unqualified distribution from the account, you would owe taxes on the gains and pay a 10 percent penalty.
As an advantage, several states actually allow for state tax deductions on part, if not all, of the contributions. In some states, matching grants may be available for those whose incomes and other criteria meet the requirements. These benefits usually only apply to those who live in the state but usually do not restrict the child from attending college in other states. Unfortunately, there are no federal tax deductions for the contributions.
Until the 529 plan came into existence, some people were using Uniform Gift to Minors Act (UGMA) or Uniform Trust to Minors Act (UTMA), which are special accounts designed for minors. For many parents, the biggest downside to these accounts occurs after the money is gifted into these accounts; parents lose possession of the funds. Therefore, when a child turns 18, or 21 in some cases, he or she would have total control of that account. I know I certainly would not have been wise about my money had I come into possession of a large sum of it at 18, or even 21.
This is another reason many parents, and grandparents, appreciate the 529 plan. It allows the donor to maintain control so if one child ends up on the wrong track in life, the money can be moved to another beneficiary of the donor’s choosing. Furthermore, while the UGMA or UTMA is in the name of the child and would count toward the child’s assets when determining financial aid, the 529 plan is owned by the parent or grandparent and would not count as much, if at all, toward the child’s assets. If possible, I advise my clients to have a grandparent own the 529 plan so those assets are not counted at all when a child is applying for financial aid. You can even name yourself as the beneficiary of a 529 plan if you are planning on going back to school.
For some people, investing might be intimidating with its myriad choices. The 529 plan simplifies everything for the investor, and most plans offer professionally managed age-based portfolios. For example, if your child will most likely attend college in 2030, the portfolio automatically adjusts over the years to meet the goal of distributions starting in 2030. Initially, the portfolio will be more heavily invested in stock accounts, but as the child grows older, the investments will shift toward a fixed income/stable portfolio.
Aside from the fact the 529 plan is a great way to save for college, it is actually a wonderful estate planning tool. Currently, each spouse can gift $13,000 per year per beneficiary without paying a gift tax. With a 529 plan, accelerated gifting up to five years is possible. If my parents wanted to gift $65,000 each into my daughter’s plan in 2012, they could do that without triggering a gift tax. They wouldn’t be able to make any additional gifts for the next five years, but this allows them to remove $65,000 per spouse (or $130,000 jointly) out of their estate. For those whose estates might be quite substantial, this would be one easy way to plan for their heirs.
As with any long-term financial goal, starting early and saving regularly can make a big difference thanks to the power of compounding. For example, if you invest $300 a month for 18 years, assuming a 7 percent rate of return, you could save more than $126,000 in time for college. Waiting just one year could cost you almost 10 percent, and waiting five years could cost you nearly 5 percent. Whether it’s $300 per month, or even $25 per month (the minimum monthly contribution for most plans), getting started is the most important step. 529 plans have made it easy to save monthly or quarterly with automatic deductions out of your checking account. Some employers even offer this service through the company with salary reductions, just like with your 401(k).
If you are at any time dissatisfied with your current 529 plan, you can always change to another plan without any tax consequences as long as the funds continue to stay in the 529 plan. However, you can only roll into a different 529 plan once every 12 months. Most people do not rollover their 529 plan to another plan because they are usually satisfied with their current plans and see no need to make such changes. But, this option is available and could make sense if you move from a state that doesn’t give any benefits to a state that does give benefits on the 529 plan.
Too often, I see people having to resort to taking a home equity line of credit or even taking money out of their IRAs. These funding sources might seem like a good idea in a pinch, but in the long run, it can be quite detrimental to your overall financial health. While loans may be available to your child for college, there are no loans available to help fund your retirement. It is important to be a positive financial role model and consider your personal financial needs as you age.
As for my infant daughter, I’m planning on opening a 529 plan and will be making it a point to have friends and family gift to the plan for holidays and birthdays. There are even websites to make this very easy for the end user, such as www.giftofcollege.com. Additionally, if I register my 529 plan on www.babymint.com, I can apply a percentage of my shopping dollars from select retailers into my 529 plan. How will you pay for your child’s college education?
Tortuga Wealth Management
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Tortuga Wealth Management, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. This information is not intended to be a substitute for specific individualized tax advice. We suggest you discuss your specific tax issues with a qualified tax advisor. Prior to investing in a 529 plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult your tax advisor before investing.