Presented by Emily Promise, AIF®, APMA®, CRPC®
It’s no secret that the cost of higher education has been steadily hiking higher and higher. Calculating the sum of money, it will take to send a child to school in today’s environment could be an eye watering exercise. The cost of sending two, three, or four, crippling.
Of course, we are not left defenseless against the financial wave that many parents can see and feel coming in the distance, we have two weapons in our arsenal for combating the incredibly high cost of sending a child to college, loans, and savings. Used in conjunction, these tools can be the difference between giving your child the start you envisioned, or having no choice but to saddle themselves with payments that stretch into their 40’s.
The cost of sending a child to school has been skyrocketing in the last few decades. A recent article by Forbes magazine cites the fact that increases in college expenses have outpaced increases in earnings per household by a factor of 8. This creates a perfect storm for families when combined with the fact that the pool of work for people without college educations seems to shrink each year. More and more students feel as if they have no choice but to attend school at all costs. You can prepare yourself for this storm by saving appropriately and understanding the tools that you must accomplish your goals; we’ll seek to understand some of these strategies and tools over the next few paragraphs.
When it comes to actually saving for college there is an important conversation that parents should have with their children about setting expectations for college. Some families decide that they want to fully cover the costs of college for their children, and for others they want to keep their child engaged by having them assume a portion of the payment. Whatever you decide, this is a family matter that doesn’t have a definitive right answer. The only mistake you can make here is failing to have the conversation at all, or deciding to have it too late, where your decision has ultimately been made for you.
It is important to involve your child in this process as they may have certain goals or desires that require special planning. Do they want to pursue a degree in medicine or law? Do they want to go to a prestigious school with a name? Or will a state school serve them just fine?
Once parents and students have determined what feel comfortable as far as a share of the cost, the next step is to begin saving and planning for any loans that may be necessary. It’s a good idea to start saving right away. Often when a child is born family and friends offer gifts and donations, this is a perfect time to set aside some money for a child to use later in life. When it comes to deciding how much to save, the old saying the more the merrier may apply. You can’t necessarily overshoot college savings, any money that the child doesn’t spend on college can easily be repurposed for a down payment on a house, or a few months of income while searching for the perfect job.
The point there being that it is never too early to start saving for college, there are even some nice tax breaks available to people who do so. One of the most important concepts to use to your advantage when planning for college is compound interest. Everyone is familiar with the idea, but many fail to leverage it effectively in college savings. One of the only predictable things about college expenses will be incurred, you can’t really say that college savings sneaks up on you, can you?
Given a definite timeframe, you can let the market, and compounding returns take your hard work and multiply it over time. The sooner you set money aside, the more work the market does, and the less you and your spouse have to do. When it comes to college savings, we need all the help we can get, take advantage of investing when saving for college and you’ll have at least one ally in the fight.
This brings up an interesting question. For forward thinking parents who can set something aside, where is the best place to do so? Your local bank? A brokerage account? While individuals should explore all options to find what fits for you, for many people this is where the 529 comes in. Most have at least heard of this savings vehicle, but few understand how it works. It goes something like this, parents, relatives, and even friends can contribute to your child’s 529 account.
The 529 is like an investment account that is specifically geared towards funding college expenses. Once money is inside the account, it grows tax deferred according to whatever investments the account owner has selected. The 529 is a government run program, and because of that, they offer only a few different portfolio options for parents to invest in. Because children are not capable of making these types of complicated investment decisions, a custodian (usually mom or dad) holds and manages the account until the child is old enough to use it. Depending on your state of residence (34 states do allow this) you may even be able to write off up to $15,000, per individual donor, that you contribute to a 529 plan on your taxes.
Once funds are inside the account they must remain there unless used for a qualified educational expense. In past years this meant expenses incurred at an accredited college, however with the most recent tax changes, it became legal for parents to remove funds for private school tuition, even in elementary school. If the funds being taken from the account are used for a qualified expense, they are taken from the account tax free. Any money taken out for a non-qualified purpose will be taxed as income AND be assessed a 10% penalty to whomever receives the funds.
There are many rules and regulations regarding distributions taken from a 529 plan, so be sure you’ve covered your bases before withdrawing any funds or you too may pay this 10% penalty. Be careful not to take more out of your account in any given year than the amount of qualified educational expenses that you occur. Some avoid this entirely by taking money from the account on a re-imbursement basis. If the distribution from your account took place in the same year that you incurred the expense, there will be no adverse tax consequences.
Other rules for 529’s concern contributions to the account. While there technically is no annual limit for contributions, unfortunately for grandma and grandpa, individuals who contribute more than $15,000 will have that money count against their lifetime gift tax exclusion. This limits the amount of money that anyone can write off in one year from contributing to one of these plans. As for aggregate limits, a group of people could contribute any amount that they see fit to a 529 in any given year.
Think of the 529 like your child’s college 401k. A special savings account designed for empowering your child to take their next step. The 529 can be used for computers, room and board, tuition, and many other expenses. You can easily determine if you have encountered a qualified educational expense on the IRS’ website!
Aside from the 529 plan there does exist a more obscure account known as the ESA, or Coverdell Education Savings Account. These accounts custodial education savings vehicles like the 529, but different in a few key ways. Namely, the investment options available to you in an ESA are much broader than those available in a 529 account. Because these accounts are run by private institutions, a range of investment options are available within them.
Like 529 accounts, Coverdell ESA’s also come with income limits, and put a limit on what you can use the money for. Unlike a 529, ESA’s allow parents to take withdrawals from the account for any expense related to schooling at any age. This means expenses related to all grade levels qualify as opposed to the 529 where only college and some tuition for lower levels of education are covered. As mentioned above however, single parents who earn between $110,000 will be locked out of contributing, married couples at $220,000. The other major difference in funding is the low cap. Only $2,000 per child can be added to a Coverdell ESA in any year.
After working through some of the data, most families should be able to find a plan that works for them. While many things can change between your child’s birth and sending them off to their first day on a college campus, it seems a few things never change. Costs are increasing! Parents who start early can combat this, however, use the power of compounding and take some of the stress off your plate by letting the S&P 500 do some of the heavy lifting. You and your spouse will be thankful for it when you see the size of the first semesters bill!
College is an exciting time in a family’s life. For your child this is the beginning of their journey. From here they will shape who they are and create friendships that will last them a lifetime. Don’t let this exciting adventure be marred by disagreements around money! Get a head start and you’ll be looking forward to graduation day rather than dreading it!
Emily Promise, AIF®, APMA®, CRPC® is a Financial Advisor with Blakely Financial where she focuses on comprehensive wealth management. emily@blakelyfinancial.com
Blakely Financial, Inc. is an independent financial planning firm located in High Point, North Carolina specializing in Financial Planning, Investment Management, Retirement Planning, Estate Planning, and Charitable Giving Strategies. Blakely Financial is affiliated with Commonwealth Financial Network.
Blakely Financial, Inc. 1022 Hutton Lane, Suite 109, High Point, NC 27262 (336) 885-2530
Securities and advisory services offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser.
The fees, expenses, and features of 529 plans can vary from state to state. 529 plans involve investment risk, including the possible loss of funds. There is no guarantee that an education-funding goal will be met. In order to be federally tax-free, earnings must be used to pay for qualified education expenses. By investing in a plan outside your state of residence, you may lose any state tax benefits.