(LOS ANGELES / September 9, 2020)
September is officially College Savings Month, and though most schools remain closed as students move forward with virtual instruction for the time being, colleges, universities and private K-12 schools are not cutting back on tuition charges. The cost of private elementary and secondary school can average $14,000 per year, depending on the region, and the cost of college continues to skyrocket.
Since the 1990s, college tuition rates have increased by approximately 200 percent for private universities and 130 percent for public universities, and they continue to rise at about 4-8 percent per year. The National Center for Education Statistics shares that as of 2018, "average annual prices for undergraduate tuition, fees, room, and board were estimated to be $17,797 at public institutions, $46,014 at private nonprofit institutions, and $26,261 at private for-profit institutions."
The reality for most college graduates, then, is that their young adult lives may begin with a massive amount of debt to overcome. If they can afford it, most parents hope to help their children avoid this dilemma, but they still need to save for their own retirement. How can parents do both? We offer some suggestions below.
Know Where You Stand Financially
Regardless of your life stage as an investor, it's always good to reevaluate how you plan to save for retirement and your children's education. Realistically, retirement should be your priority, so it is imperative that you consult with your financial advisor to make sure you're on the right track
Ask yourself how many more years you want to work before retiring and review the projected balance(s) of your retirement account, pension plan, and/or employer-sponsored retirement plan with your advisor. Factor in any Social Security, and make sure your anticipated standard of living in retirement is aligned with your current expectations.
If you want to travel, then you should plan accordingly and make necessary adjustments. Do you need to tighten up monthly expenditures? Is working part-time during retirement a consideration for you?
Obviously, circumstances can change quickly, but asking the right questions and continuously reevaluating your goals will enable you to both establish a savings plan that will help your children meet their educational aspirations and save for your own retirement, simultaneously.
Start a 529 Plan: The Earlier, the Better
A 529 Plan, or Qualified Tuition Plan, is always best when started early on in a child's life, but it's never too late. This type of savings plan allows investors to save for their children's education, tax-free, as long as the funds are used to pay for "qualified higher education" expenses. There are two types of 529 plans that can be obtained through a designated financial institution (your financial advisor can provide guidance), and the differences are important.
A 529 Prepaid Tuition Plan is normally state-sponsored and, therefore, comes with some residency restrictions. The upside of prepaid tuition plans, though, is that the price of a selected future list of schools in each state is set at current-day prices. This is surely beneficial if you have a toddler who will attend school in a state like California eighteen years from now. The plan, however, comes with residency requirements and can only be used for in-state tuition, and not room and board.
A 529 Education Savings Plan allows for more flexibility, plus, funds can be placed into investment accounts like ETFs or mutual funds of the investor's choosing - where they can grow tax-free. Investors can purchase 529 Savings Plans in any state based on the plan that suits them best, unlike 529 prepaid tuition plans, which are restricted to the state of residence. The term "qualified higher education expenses" also takes on a more inclusive meaning, as funds can be used for expenses beyond tuition, such as fees, room and board, and books. Contribution limits are also as high as $350,000, which will be helpful if your child decides to attend an Ivy League school or private university.
Parents and Grandparents can also use 529 Savings Plans to place "lump-sum" gifts in multiples of the permitted annual tax gift exclusion amount, which, as of 2020, is $15,000. The maximum allowed lump sum amount is $75,000 per person or $150,000 for a married couple.
While a 529 is one of the most common and advisable ways to pay for your child's education, there are other ways investors can fund it as well.
Coverdell Education Savings Account (ESA)
Another tax-deferred way to finance your child's education is through the use of a Coverdell Education Savings Account. However, Coverdell accounts are restricted to students aged 18 or younger, and the maximum contribution amount is $2,000 per year, per beneficiary. While such accounts are generally used for primary and secondary school, if the account is started when a child is very young, it is simply another way to finance their first year of college.
Put Money into a Custodial Account
Some investors place funds in a UGMA (Uniform Gift to Minors Act) or UTMA (Uniform Transfer to Minors Act) custodial account, held in their child's name, to fund education. Both types of accounts are almost identical and can hold assets like cash, stocks, mutual funds, bonds, and even real estate, with no contribution limits. Because custodial accounts aren't limited solely to educational costs, they can be used for both living and other miscellaneous expenses things that may come up during the course of the child's higher education.
It's important to note, however, that once a child turns 18, they are granted full, irrevocable access to custodial accounts, which means they become the sole owner. While 529 Plans remain controlled by parents, custodial accounts are owned by the child once they reach the age of majority (usually 18), so depending on the circumstances it may be best to stick with a 529 Plan.
Put Money into Eligible Savings Bonds
Yet another option to consider is the placement of money into eligible savings bonds for future use. Because they are tax-free if used for educational purposes, guaranteed by the government and offer little to no risk, they can be a good option for some. However, the interest earned is generally very low compared to at least a 3 percent interest rate earned on the average 529 Plan. Also, the rules for using these types of funds for education can be complicated, so it's best to discuss this option with your financial advisor.
Using Retirement Accounts to Pay for College
Last, though not generally advisable, an IRA or Roth IRA could be a consideration for funding a child's future education. Like 529 plans, these types of accounts are tax-advantaged savings accounts.
If an investor opened a Roth IRA early in his or her career and made the maximum $6,000 a year contribution, for example, the upside is that even if a distribution is taken prior to age 59 ½ to finance a child's education, it will not be taxed as long as the funds are used for qualifying educational expenses.
As an investor, it is best to avoid using any employer-sponsored plans like a 401(k) plan to pay for a child's education, because if even if a distribution is taken under age 59 ½, even for college funds, a 10 percent penalty fee will be assessed.
While the most prudent path for investors is to start preparing to fund a child's higher education in their first years of life, it isn't always an option. There are still several creative ways to plan and save for your child's higher education, and it's never too late to start. If you have questions about doing so, call your financial advisor or reach out to B. Riley Wealth Management.