With school years flying by for children, it’s a good time for parents and grandparents to begin thinking about planning for college expenses. It is especially important to begin saving for college as early as possible to allow for investment returns to compound over time. Whether you are the parent or grandparent of a child, future college expenses will likely be quite shocking when compared to past and current expenses. According to the College Board, for the 2015-2016 academic year, in-state tuition and fees increased 2.4% for public four-year institutions and 3.6% for private four-year institutions. Over the past 10 years tuition and fees for public four-year institutions have increased by 35%! Now that I have your attention, let’s focus on your homework.
- Help me open an account
One of the most advantageous ways to save for college is through a 529 College Savings Plan account. These accounts can be set-up so that they are considered an asset of the parent or grandparent and grow tax-deferred. Even better, as an asset of the parent or grandparent, only 5.65% of the value counts against financial aid (this compares to 35% if the child has a UTMA/UGMA account). Investment options differ for each plan, including some that offer age-based plans that automatically reduce the equity allocation and increase the fixed income allocation as the child gets closer to school age. For instance, when the child is five years old the account may be invested 100% in a stock fund. It will gradually get more conservative until it ultimately ends up 100% invested in bond and money market funds when the child turns 18. When the child reaches college age, withdrawals are tax-free if used for qualified education expenses.
- Choosing the right plan
Now that you have decided to put money aside for college expenses you want to select a 529 Plan account. Sounds easy, right? Not exactly. Each state offers its own plan and many offer multiple plans (www.savingforcollege.com lists 112 plans on their website). The good news is that your choice of a plan is not affected by your residence or the state in which you expect your child to attend college. You can be a California resident, invest in a Vermont plan and send your child to college in Nevada. However, before you go opening any old account, you may want to consider the following:
- Is there a state resident benefit? Some states offer tax incentives such as credits on your state tax return or a match on your contributions to encourage you to use their plan.
- Who is the program manager? What investment options are offered? What are the respective fees? Some plans use funds with higher than average fees or charge an annual account maintenance fee. Others have poor investment choices, such as the absence of an international stock allocation.
- What are the minimum and maximum contributions allowed? If you don’t plan on making a sizeable contribution up-front, but instead intend to add money over time, it’s important to check the initial contribution limits. Conversely, if you are trying to set aside as much money as possible, you’ll need to know the maximum contribution limits.
- Making contributions
Speaking of contributions, annual gifting rules allow you to give any one person $14,000 ($28,000 if you elect to split the gift between you and your spouse). Thus, if you have ten grandchildren, you could open up ten accounts and deposit $14,000 ($28,000 if married) into each account for a total of $140,000 ($280,000 if you are married). You are allowed to make this annual contribution without using a portion of your gift and estate tax exclusion amounts. The IRS permits each individual to increase gifting into 529 Plans by front-loading five years of gifting for each child and contributing $70,000 ($14,000 per year x 5 years) at once. In such a situation, no further gifting to the same child is allowed without tax consequences for the next five year period. We would recommend that you check with your accountant prior to making any decisions regarding the amount you wish to contribute.
- The looking glass
You may be asking, “How do I know if my child or grandchild will go to college 10-20 years down the road? What if there is money left over at the end of college? What if I need the money back?” There’s good news for you. Most plans allow you to change the beneficiary on the account to another related family member. So, if your son decides to become an entrepreneur at the age of 18 and skip college, you can always transfer the assets into your daughter’s, cousin’s, or grandchild’s name. Likewise, if the child gets a scholarship to a prestigious college and only needs half the money, you can take a penalty-free withdrawal, use it for their graduate school expenses or you can always transfer the balance to another family member’s account. And since the account is in your name, you maintain control of the funds and can reclaim them any time you desire. There is a 10% penalty on the earnings (not the principal contributions) for non-qualified distributions, but this is waived if the beneficiary has died or become disabled. As a result, you can make contributions and remove these assets from your estate, and then take them back if needed – this is the only strategy that allows you to do this!
If you are considering putting money away for someone’s future education expenses, the flexibility of a 529 Savings Plan account makes a lot of sense. At Evensky & Katz/Foldes Financial, we continually review and research the plans available in order to assist our clients in making an appropriate choice. As always, if you or someone you know would like to contact us on this topic, we’d be happy to speak with them.
Feel free to contact Brett Horowitz with any questions by phone: 305.448.8882 ext.216 or email: BHorowitz@EK-FF.com