Intelligent Options for College SavingsSubmitted by Durbin Bennett on March 21st, 2016
Regardless of the ages of your children or grandchildren, chances are good that the escalating costs of higher education have crossed your mind.
Consider the following statistic: a 2014 study by Bloomberg found that since 1978 college tuition and fees have increased in price 1,225%. Over the same period of time, medical care--another ballooning source of costs--increased by just 634%, while inflation clocked in at a paltry 279%.1
What are the implications of this unprecedented increase in higher education costs? With costs rising this fast above inflation, it seems apparent that students cannot count on bootstrapping their way through school by working summers to pay the entirety of their annual college bills.
At the same time concerned parents and grandparents of soon-to-be students would be well served to take matters into their own hands by starting to save for college sooner rather than later.
What are the different ways of saving for higher education?
Fortunately, there are a variety of education savings plans available to students and their families. Unfortunately, each savings plan has advantages and compromises that may not be readily apparent, and plan selection is a financial decision with long-lasting consequences. As such it’s worth talking through all the options with Durbin Bennett, but in the meantime here is an abbreviated crash course in a couple of the most common plan types.
Coverdell Education Savings Accounts
Coverdell accounts, also known as Coverdell ESA’s, allow after-tax savings to be set aside and grown tax deferred. The proceeds of the account can then be withdrawn free of tax for qualified education expenses, including elementary and secondary school. As an added plus, it’s possible to change the beneficiary to another eligible member of the family if circumstances change. Combined with the ability of these accounts to be invested in stocks, bonds and funds, Coverdell ESA’s are a flexible way to set money aside for future education needs.
The downside is that contributions to these accounts are capped at $2,000 per year per child and eligibility to contribute phases out at higher income levels. Students considering expensive private schools, graduate schools, or those with high net worth families may find alternative plans to be a better fit. The Coverdell value as an estate planning tool is also limited, as they are required to distribute assets by the time the beneficiary reaches age 30, limiting the power of compounding returns over time.
A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college expenses. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996. 529 plans provide the ability to channel after-tax money into a dedicated education savings vehicle that allows for tax free withdrawal for qualified higher education expenses. 529 plans can offer state income tax benefits, although rules and restrictions apply. 529 Plans can be used to meet costs of qualified colleges nationwide. In most plans, your choice of school is not affected by the state from which your 529 savings plan originates.
Unlike Coverdell accounts, 529 plan contributions and gifts are not limited by income or by age. In fact, it’s possible to gift as much as five years of annual gifts at once, allowing for $70,000 per person to be set aside immediately in a 529 plan. This allows parents and grandparents to invest a significant asset pool early and have it compound for many years. Since 529 plan earnings not used for qualified education expenses will incur both ordinary income taxes and a 10% withdrawal penalty, it’s worth monitoring funding levels so as not to accidently over-fund the account. Knowing the differences between qualified and non-qualified expenses is also important:
- Qualified withdrawals include:
- Tuition and fees
- Equipment required for course enrollment (including special needs equipment)
- Some room and board expenses
- Non-qualified withdrawals include:
- Transportation costs
- Computers (unless the school requires them)
- Student loan repayments
With all of that being said, 529 plans allow for graduate studies, professional or trade school, and changes to the beneficiary. 529 plans are not capped by age, meaning that (when combined with the higher contribution limits) they are ideal for certain estate planning situations.
While the pros and cons of Coverdell ESA’s and 529 plans are complex and include factors not listed above, one thing is clear. Given the ever-rising costs of education, it makes sense for families to consult with their financial professional about the different savings options in order to maximize the proper approach.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2014-2016 Advisor Websites.