By Bryan Kudera
Anyone who’s ever been to a toddler’s first birthday can relate to a few common themes… a clown or superhero, crying babies (especially if Mom and Dad picked the clown), a Smash Cake, and someone offering up a college fund. This gift from Grandma or your Brother-In-Law that works at the bank might be the most boring, but any recent college grad will agree it’s one awesome gift.
In today’s day and age, it’s not uncommon for a 4-year college tuition to cost over $100k, and that’s not including room and board! If you have more than one child, just start multiplying that 6-figure bill. So as the price of attending college continues to skyrocket, averaging about an 8% increase per year and in some years being as high as 6.5x the general inflation rate, how does a family plan ahead?
The most common and heavily marketed savings vehicles is the 529 College Savings Plan. Each state sponsors their own plan. There is a “Prepaid Tuition” variety, that some in-state and public colleges offer, which allows an account holder to buy credits at the participating college and lock in today’s cost of tuition. However, if the beneficiary does not attend that college, the account holder will receive his/her money back with a small return. The more common “Education Savings Plan” provides investments in mutual funds or ETF’s with tax-deferred growth and tax-free distribution if used for Qualified Higher Education Expenses. Savers should notice each individual state’s potential matching grants or income-tax deductions. Beware, any withdrawals not used for higher education will be subject to income taxes and a 10% penalty on earnings, and these accounts may impact financial aid.
The less popular Coverdell Education Savings Account (commonly called an “ESA”) only allows a saver to contribute up to $2,000 per year, offering similar tax advantages as the 529. The draw here used to be that funds could be used for college OR K-12 expenses. However, since the Tax Cuts and Jobs Act of 2017, 529 plans may now be used for K-12 as well. These accounts do permit much more investment options, including stocks, than the 529 counterpart. As ESA’s go by the wayside, they are now allowed to be rolled over to 529 Plan’s to simplify things.
The third often looked at option is an UGMA (Uniform Gifts to Minors Act) or UTMA (Uniform Transfer to Minors Act), typically called a custodial account. These investment or cash accounts are funded by irrevocable contributions to a beneficiary that can never be changed. Once the child reaches age of majority in their state (typically 18-21) they have full access to the account. Parents need to be aware of potential tax implications as investment earnings over $2,100 will be taxed at their rate (the Kiddie Tax). The other drawback is that for college financial aid, a custodial account is considered an asset of the child and will be more heavily weighted.
Some other frequently used, but rarely planned for, vehicles of college funding include real estate. More and more parents are taking out 2nd mortgages or Home Equity Lines of Credit (HELOC’s) to tap their biggest asset on a tax-free basis to pay for education. The family home and any of its secured debt is not considered for FAFSA. Another tool not included in financial aid formulas is Cash Value Life Insurance. Such policies can provide self-completion in the event of death or disability, tax-favored access to cash values, parental
control to any age, guaranteed growth, and usable for any goal. Roth IRA’s also provide multiple solutions, typically used as a tax-free retirement investment account,contributions can also be withdrawn for higher education tax and penalty-free.
Hopefully this snapshot will help you start saving for your kids’ or grandkid’s education and put an end to the rampant student loan epidemic.
References:
1. www.Collegeboard.org 2017. Private, non-profit 4-year college without room and board. 2. www.finaid.org 2018. “Tuition Inflation”
3. www.sec.gov 2018. “An Introduction to 529 Plans”
4. www.irs.gov 2018. Tax Topics.
5. www.cnbc.com “Using Roth IRA to Pay for College”. Scott Hanson.