Working with clients over the years, I have found funding the cost of college tuition and related expenses for children is a common source of concern for parents and grandparents who worry about the ever-increasing costs of a college education in the United States. With the average cost of one year of tuition, fees, room and board at a four-year private college costing $48,510 for the 2018- 2019 school year1, it is no wonder that parents are concerned about saving enough to cover these costs.
Although many are concerned, only 57 percent of parents are actively saving for their child’s education, according to Sallie Mae2 and hold an average of only $18,135. In addition, most of that money is held in general savings accounts, not tax-advantaged educational savings vehicles.
If you intend to pave someone’s path to higher learning, there are a number of options to consider.
Section 529 College Savings Plan
529 plans are a popular choice for many families for their generous contribution limits and potential for tax-free qualified withdrawals. A grandparent can lump together up to five years of gift tax exclusions for a $70,000 one-time contribution ($140,000 for a joint contribution). States also offer tax breaks on plan contributions. Prepaid tuition plans in your state are also an option but can limit choices to participating colleges, usually within that state.
Coverdell Education Savings Account
A Coverdell Account is a trust or custodial account that enables money to be saved toward qualified education expenses of a designated beneficiary, however, contributions are limited to $2,000 per beneficiary from all sources per year. If your modified adjusted gross income is less than $110,000, you can use contributions to cover qualified higher education expenses or elementary and secondary education expenses, a key difference from other education accounts. Contributions grow tax-free and qualified withdrawals are free of tax at the federal level and often at the state level. Any funds left in the Coverdell ESA must be distributed to the beneficiary when he or she reaches age 30, unless that person has special needs.
You also can make a contribution under the Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA), but many avoid this path because the contributor loses control of the assets once the child reaches the age of maturity (usually 18 or 21). At this point, the account, which is irrevocable, becomes the property of the child who can use the money for any purpose whatsoever with no guarantee the money will be used for his or her education.. Also, the child’s assets will work against financial aid calculations.
Roth IRA or Other Investments
If you qualify, you could open a Roth IRA (2019 limit: $6,000; $7,000 if you’re 50 or older) with the idea of using some of your contributions (not your gains). You can extract your after-tax contributions at any time, for any purpose, while leaving your gains to grow tax-free to support your retirement. Or consider tax-efficient investments; your withdrawals won’t be tax-free, but they can be used for any purpose without any penalties to consider.
Each Family’s Situation is Unique
There is no exact science when it comes to putting together a college savings plan. Each family’s individual circumstances must be taken into consideration. When developing a plan, however, it is important for families and their financial advisors to clarify their expectations and look closely at the various savings vehicles and their tax implications, as well as their impact on financial aid.
As with any investment strategy, a regularly scheduled review process is also necessary, as tax laws and family situations continue to change. Making the college savings plan part of the annual financial review process is recommended.
If you’re thinking about starting or adding to an education funding plan, give us a call. We can help walk you through the options and help you select a plan which works best for you and your loved ones.
1 (Source: “Trends in Higher Education. Trends in Higher Education Series”, The College Board – https://trends.collegeboard.org/college-pricing/figures-tables/average-published-undergraduate-charges-sector-2018-19)
2 (Source: Sallie Mae “How America Saves for College – https://www.salliemae.com/assets/about/who_we_are/How_America_Saves_for_College_Infographic.pdf)
Rules and laws governing 529 plans are varied and subject to change. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
Raymond James does not provide tax or legal services. Please discuss these matters with the appropriate professional