Planning For College Expenses: 4 Things to Think About
One of the most challenging parts of planning for a child’s college education isn’t waiting on the acceptance letters to arrive – it’s about figuring out how to pay for it. Long before your child is selecting what foreign language to study or is focused on advanced calculus, their college savings plan should be in place and growing.
So when do you start? What’s the right investment strategy? Should it change over time? These are just a few of the biggest questions you may have. Let’s explore four ideas to consider.
1. Start Early – Time is Your Ally
This concept is quite simple, but still powerful: the earlier you start, the longer you have for your savings to grow. If you have at least five years before you’ll need to access the funds, an investment account is a good option. Remember, the average cost of four-year college tuition can range from $10,000-40,000 per year1, not including room and board, so you may need to save more aggressively than you think.
2. Save Smarter – 529 Plans Provide Tax Advantages
529 Plans are tax-advantaged savings plans specifically designed to help parents pay for their child’s education (although, they can be used by more than just parents). Also, did you know 529 Plans are not just for college anymore? Changes to the tax code in 2017 made tuition expenses for K-12 schools eligible for tax-free withdrawals up to $10,000 per year, although state tax treatment of K-12 withdrawals varies. While contributions are not deductible at the federal level, earnings grow federal tax-free, and there is no federal tax on withdrawals used to pay for qualified education expenses. Depending on your state, you may be able to deduct contributions from your state tax return up to a certain level as well.
All 529 Plans have a plan manager that determines the portfolio of investments. You’ll be able to create a portfolio from a menu of mutual funds and ETFs and tailor it to your time horizon and investment preferences. If you’re married, both you and your spouse can contribute up to $15,000 per year each (in 2021) and still fall under the annual gift tax exemption. You can also frontload the account with up to five years’ worth of your annual exclusion gifts, so your child’s 529 could begin with a balance of $75,000 up to $150,000 with joint gifts. Keep in mind that funds inside a 529 Plan must be used for qualified education expenses, and any funds withdrawn for anything else will be charged a 10% penalty and taxed at ordinary income rates. That said, you don’t want to overfund the 529 Plan.
The key to saving is to do it consistently. One tried and true method: figure out your budget, determine the amount you can contribute and setup automatic monthly contributions to the investment account.
3. Custodial Accounts Can Also Add Value
Consider an UTMA account for savings outside of a 529 Plan. I just opened an UTMA account for my daughter, who is under a year old. Under the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act (UGMA/UTMA) I created a custodial account in my child’s name. This can be done at a bank or with a brokerage firm. The account can be used to deposit gifts of cash that she receives – for instance, birthday or holiday checks from grandparents or other generous family members. When she reaches a certain age, in this case 21, the account will belong to her. This is a great way to keep your child focused on college and teach them some basic financial skills down the road.
4. Adjust the Allocation Along the Journey
Similar to a strategy of adjusting your portfolio allocation to be more conservative as you get closer to retirement, your child’s college savings accounts should be monitored and reallocated as they progress through high school. The theory being as the time horizon on needing the funds gets shorter, the asset allocation should adjust to be more conservative preserving the growth you’ve attained.
The Takeaway
Like any other goal, such as buying a home or investing for retirement, consistent savings and a solid financial plan can get you to the finish line. Your financial advisor can help you deploy the tools you need to get you and your child where you both want to go.
1 The College Board reports the average cost of four-year colleges for the 2019-2020 school year was $10,560 for public schools (in-state) and $37,650 for nonprofit private schools, only including tuition and fees.
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