It is no secret that the price of higher education has been increasing at a concerning rate for quite some time now. In fact, these costs have been growing at about twice the rate of general inflation during the past 10 years (about 5.0% per year). Politics aside, as college costs continue to be the heart of many debates, it is vital for anybody who is hoping to assist in their child’s future education to learn about the many different options that are currently available and to make the most out of those options.
According to College Board’s “Trends in College Pricing 2019” report (I’ve decided to omit 2020 costs due to the education disruption from COVID-19 impacts), the average cost of public and private colleges were $26,590 and $53,980 per year, respectively. [These amounts include tuition and fees, room and board, books and supplies, and transportation/personal expenses.] When we add in the previously mentioned inflation, of course this goal might feel overwhelming. However, there are plenty of approaches you can take to make this a bit more manageable. Remember, the biggest advantage that you have is planning. And planning early!
Beyond the costs, I see a lot of the stress that parents have coming from the thought “I don’t make enough each year to afford it” or “I’ll never be able to save enough by the time my child starts school.” These statements are approaching education funding as if there is only one way to accomplish the goal. In reality, it is not income at the time or savings that will do it. It is a combination of income and savings and scholarships/loans that can get you to the finish line.
Like all other financial planning, the earlier you can get started, the better. With respect to the three approaches noted above, this means starting with contributing to savings, as the other two will not be determined until your child starts school. There are plenty of ways to save, but I have outlined a few of the most advantageous accounts below.
- UGMA/UTMA: This is a basic investment account in minor child’s name and funded by parent(s). These accounts are subject to annual gifting limits, subject to capital gains taxation, and control is turned over to the child once he or she reaches the age of majority (age 18 or 25 depending on account type).
- Coverdell Education Savings Account (formerly known as Education IRAs): Coverdell accounts have the benefit of tax-free earnings and distributions. However, contributions are limited to $2,000/year and are subject to income limitations.
- 529 College Savings Plans: These are the most common education savings plans and are sponsored by each state. Earnings and withdrawals are tax-free if used for qualified education expenses, and contributions are subject to the higher annual gifting limits. Depending on the state you live in, you may also be eligible for state tax credits on a portion of your contributions.
- IRA/Roth IRA: While these are considered retirement accounts, some parents choose to use them as a source for education funds. This is because qualified education expenses are an exception to the usual 10% tax penalty on non-qualified distributions. (Reminder: There is a difference between planning and using it as a savings vehicle for education vs. taking away from your already established retirement goals.)
[Keep in mind that the information above lists just a few highlights of each account and a professional should be consulted to determine what is best for your situation.]
Regardless of the situation, you should always complete the appropriate financial aid application. The most common are the FAFSA and CSS Profile, depending on the type of institution the student is considering. In either case, the two main drivers for aid are based on income and assets. You should also know that income is the main contributor to your estimated ability to pay. This is important to know, as many parents attempt to relocate or spend assets to lower their expected contributions, while in a lot of cases it may barely move the needle.
What matters most with assets is who owns them: the student or the parents. Assets held in the student’s name are weighted much more heavily than those in the parents’ name(s).
Without getting into the weeds, be aware that various tax deductions and credits are available. These apply to qualifying costs paid throughout the school year and student loans. (Reminder: Taxpayers cannot double-dip on tax benefits and scholarships, grants, employer assistance, etc. must reduce the amount of expenses you claim.)
[As you might expect, a financial/tax professional should be consulted as there are many factors that determine your eligibility.]
Obviously, the information above will not answer every question you might have. There are many steps throughout the education funding process and taking the time to read this over is one step in the right direction. I encourage you to get started as soon as possible. The next step should be setting up a meeting with your financial advisor to discuss the questions you have and the help you may need. This could include basic conversations, funding projections and analysis, creating a savings plan, planning distributions, and everything else in between.
Yes, it will take time and a good amount of effort, but I believe you will find the potential tax savings, efficient funding, optimization of financial aid and overall reduction of stress to be well worth it.
As we embark on this clarifying journey together, I encourage you to submit any ideas, topics, or questions to firstname.lastname@example.org. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation. Clarify Wealth Management and LPL Financial do not provide legal advice or services. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.