Saving for college is the real deal. It is getting more expensive by the day and it is becoming increasingly difficult to keep up with the rapid level of inflation of college as the years go by. In addition, if you are sending or planning to send your kids to private primary or secondary school, it is almost impossible to even think about saving for college. There is some good news--the new tax reform bill has opened up 529 plans to be used towards primary and secondary education so there are some very interesting opportunities to use 529 plans in the next few years. Read on to check out more about a 529 and what to consider when getting one.
Why a College Planning is a Must for Parents
First, let’s start by acknowledging that the cost of college is totally insane. I am not sure how we got here or where this is all headed but today’s college costs are astronomically high and on the rise. My kids are small so college is another 13-15 years from now. The good news is that I have some time to plan, save and invest. The bad news is that college costs rise on average about 6% per year, a growth rate that far exceeds the pace of current inflation and wage growth (FinAid.org). Therefore, in order to keep up with the college inflation costs, you likely have to be invested and earning at least 6% per year.
When I think about college planning, I assume that the costs will be exponentially higher in 2030 when your child will be a freshman (of course this will be at Harvard with a full ride, according to my mother-in-law). So what do you do now to a) save enough for the year 2030 and b) strive to do it in the most efficient way? Buckle up, people! I have answers. But first, here are some sobering statistics:
According to the Department of Education, in 2030, annual public tuition will be $44,047 per year. The total cost for a four-year public degree could be more than $205,000. There are two important things to point out here—1) this number does not include room, board, food, books (will they even have books in 2030?). 2) This number represents public tuition. My son is going to Harvard! Harvard is likely to cost about $125,000 per year by 2030. That puts the four-year cost at $500,000. This is for one kid. I have two of them!
According to a survey conducted by Fidelity’s annual College Savings Indicator Study, parents surveyed said they plan to pay 70% of the total cost of college. However, 50% of the same parents surveyed think they can meet their college savings goals if they start saving by the time their child enters the ninth grade. Um, what!?! If decided to wait until my son was a ninth grader, I would have to save $62,500 per year in order to make it until his senior year of college. That’s after I pay taxes. Math tells me that I would have to earn $125,000 per year and divert it all towards college before I ate, paid my mortgage or bought clothing. Have I made my point? We need to prioritize saving for college now.
How Much Do I Need To Save?
First, it’s good to think about how much of your child’s tuition you want to assume as your responsibility. When college could potentially cost half a million dollars, it is ok for your kid borrow some money. Of course, we all want to do as much as we can for our kids, but it is much more important for you to be saving for retirement than for college. Remember the old adage: “You can’t take out a loan for retirement.” My rule of thumb is that my kids can pay for 10-15% of college. Assuming they both attend a 4-year private college (most expensive scenario) and the cost is $500,000, they can borrow $50,000-$75,000 and pay that off over time. They will work it out.
The next step is to figure out how much you will need to save each year in order to achieve our goal by year 2030, in my case. If I allocate about $12,000 per year per kid and have it invested in a vehicle that returns approximately 7% per year for 17 years, I will have $433,900 by the time my first kid graduates. (This is compound interest at work). If my first born borrows the rest, we are in good shape. Let me allow you the moment where you say “excuse me lady but $12,000 per year per kid is an absurd amount of money!” Yes, I know it is. Use this number as a target or a guideline and remember that any dollar invested now is a dollar you will be thankful for later. Start outlining your goals.
How Do I Invest The Money In the Most Efficient Way?
There are several ways to save for college. You can open a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA), a Coverdell Education Savings Account (ESA) or you can set money aside in a taxable account. However, the features of a 529 college savings plan distinguish it from the rest. Each state offers a different plan. In some states, like NY, they offer more than one plan. It is crucial to research how your state’s plan works. Do this research or find a financial advisor to help you. This information could be very helpful to you over time.
I will use New York State’s plan(s) as a practical example. The Great State of New York offers you a tax deduction of up to $10,000 of your total contributions. [NOTE: Not all states offer tax-deductions and deductions vary from state to state--NJ does NOT offer a tax deduction but if you work in NY, you could be eligible for one.] We love tax deductions! You should consider investing the contribution into one of the two state plans and pick your investment profile based on your risk tolerance. Over time, this money grows tax-deferred. We love tax-deferred! When it is time for your kid to go to college, you can withdraw the money without paying federal tax on the investment gains, assuming that the money is being used towards education costs. It is very important to point out that tax-deferred growth and tax-free withdrawals are very nice gifts from the government and we should embrace these gifts, but of course, that is just my opinion!
What If I Am Also Paying for Private School?
There is some good news on this front. With the new tax reform bill, the government is now allowing us to use 529 contributions towards private or parochial elementary and secondary education. The limit is $10,000 per year per child but I think it’s still pretty fantastic. Think about this scenario: you can fund the 529 plan up to $30,000 if married per year per kid so the ideal strategy is to fund at least $10,000 for private school and then aim to fund an additional $12,000 per kid for college. This may allow you to take advantage of the tax deduction and for your tuition money to grow tax-free. Make sure to discuss this strategy with your CPA and your financial advisor. Remember that not all states give you a tax deduction (example: NJ and CA).
Few Important Things to Remember about a 529 Plan:
You have limits on your contributions but you can rope the grandparents in! You can contribute up to $15,000 per person per year for 2018 (this is up $1,000 from 2017). This aligns with the gift-tax transfers. Others can make contributions to your plan as well like grandparents, aunts, uncles. One can make up to $75,000 contribution to a 529 per beneficiary in a single year and treat it as a lump sum over a five-year period. If there are wealthy grandparents in your lives who are looking to give money out and avoid gift taxes, this can be a fabulous option.
You can transfer it to another child —Typically, a parent or grandparent opens the account and names a child as the beneficiary. If the child gets a scholarship or doesn’t go to college, the beneficiary on the account can be modified to whomever you wish.
529 plans can alleviate the impact on financial aid — because the savings plans are considered parental assets, they are factored into federal financial aid formulas at a maximum rate of about 5.6%, according to Fidelity. This means that only up to 5.6% of the 529 assets are included in the “expected family contribution (EFC)” that is calculated during the federal financial aid process. That is much lower than the potential 20% that is assessed on student assets such as UGMA/UTMA accounts. [Note: if a grandparent owns the 529 plan, at the time of distribution, the assets will be treated as income to the child and could very much impact the Free Application for Federal Student Aid (FAFSA).]
What if both kids get a scholarship? — I get this question quite a bit. What happens if there is money left over after the kids are done with school? The money is still yours but you will pay a 10% penalty and ordinary income taxes on the earnings. To avoid these penalties, you could transfer the account to a different beneficiary who plans to go to college. 529 money can also be used for graduate school. You can also change the beneficiary to yourself and use it at some point if you want to take a class. Also, if you become disabled, you can access the 529 tax-free so down the road, it could be used for long-term care.
You can use any plan you want — If you live in a state that does not offer a state tax-deduction, it may make sense for you to use another state’s plan. Plans vary drastically from state to state and there are some that are better than others. Do the research or ask your financial advisor.
Embarking on the college-saving process is a daunting but crucial process. If you are unsure about your strategy or don’t have one, consult a financial advisor. Investing early and often will make an impact on your financial future so start today!
Kristin O’Keeffe Merrick is a money expert and financial advisor at her family-run firm, O’Keeffe Financial Partners, in Fairfield, NJ. Kristin works with families, business owners, non-profits and creatives to devise bespoke financial plans and to help clients work towards achieving their money goals. Kristin also speaks and writes about financial literacy. She is a contributor to Forbes and Girlboss and has been featured on the Today Show, Real Simple, House Seven and My Domaine.
Securities offered through Raymond James Financial Services, Inc. Member FINRA/SIPC. Investment Advisory services offered through Raymond James Financial Services Advisors, Inc. Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 college savings plans before investing. There is a risk that these plans may lose money or not perform well enough to cover costs as anticipated. More information about 529 college savings plans is available in the issuer’s official statement. Tax implications can vary greatly from state to state. State specific benefits can include financial aid, scholarship funds, and protection from creditors