The College Savings Conundrum
Education is one of the greatest gifts we can give our children. There are many different types of education we can offer to our children in an effort to open their minds and their hearts, with the ultimate goal to send them off into the world to grow into adults who are all at once, financially, emotionally and spiritually successful. No matter the course or path we put our children on; each family will also be faced with the stark reality of the costs of higher education.
There has been much debate recently around whether higher education, and more specifically, the cost of a traditional college education, is worth it. According to Bloomberg, college costs have increased 500% since 1985; that’s higher than health care costs and gas prices combined! In South Carolina, over the past 10 years, both in-state and out-of-state tuition costs have seen a cumulative increase of 60%. With these burgeoning costs, it’s logical to ask whether or not college is really worth it.
A recent study by Pew Research found that the earnings divide between college graduates and high school graduates is particularly wide in the current millennial generation. In 1979, high school graduates of the Baby Boomer generation earned about 75% of what their college-educated peers did. Today, millennial high school graduates bring in just 62 cents on the dollar compared to their college educated peers. As education increases, so too does ones earning potential.
If you decide college or post-secondary education is worth it for your child, how will you save and pay for it?
The good news is there are several ways. It’s important to evaluate the nuances of each to determine how effective they can be at helping you meet your college-savings goals. Below are just a few to consider:
529 Plan account: Named after Section 529 in the Internal Revenue code adopted in 1996, which allowed states or educational institutions to create college savings programs for families. A benefit of these plans is that dollars contributed to them can be withdrawn tax-free as long as they are used for qualified educational expenses. There are many other benefits to a 529 plan for college bound children, but all plans are not created equally. The good news is that you are not limited by state, most 529 plans, regardless of your residency, are open and available to you. Some states provide tax credits, while 31 states allow income tax deductions against annual contributions, others states don’t cap annual deductions, but cap deductions against the lifetime contributions for each child.
Lucky for us, South Carolina currently offers the highest deduction at $370,000. Additionally, South Carolina’s plan is considered “direct-sold”, meaning it is sold direct to residents and as a result, has some of the lowest costs nationally.
A major disadvantage to a 529 plan is that if you withdraw funds in excess of your qualified education expenses (i.e. for a purpose other than education), the IRS will assess a 10% withdrawal penalty on these funds. If earnings are included in the total, you will have to pay regular income tax on them as well. Bottom line: Great for the college bound child, but don’t over-fund.
Uniform Gift to Minors/Uniform Transfer to Minors account: UGMA/UTMA accounts provide a way for families to save on behalf of a minor child without setting up a trust fund. One of the key advantages of UGMA/UTMA accounts is flexibility; you can put a large range of investment options inside a UGMA/UTMA, including stocks and mutual funds, creating a custom portfolio designed to meet the child’s unique investment goals. When funds are withdrawn, their use is not limited to qualified educational expenses, the funds can be used as the donor or child (upon the age of majority) sees fit, and there are no contribution limits.
The assets become the child’s property when he or she reaches the age of the majority (18 or 21, depending on state of residence). This is a potential drawback, because it leaves the donor with no real control over how the money is spent. The second is that for college-bound children, substantial UGMA/UTMA assets can tend to work against them in financial-aid calculations. Finally, the money “gifted” to the child is irrevocable. Bottom line: Great for an investor who wishes to make an irrevocable gift of securities or cash to a minor.
Coverdell Educations Savings Account/Educational IRA: This account is an educational savings vehicle for families looking to save for college and k-12 education. Like the UGMA/UTMA, this vehicle offers flexibility of investment choices. Like the 529, dollars withdrawn are tax-free as long as the proceeds are used for qualified educational expenses (here, inclusive of k-12). There are, however, some unique features of the Coverdell ESA: maximum investment per beneficiary is $2,000 per year, contributions must end by age 18 and the child must use the assets by age 30. Bottom line: Great option for families saving for k-12 private education; savings strategy can be combined with 529.
When planning for education, or any life event, it’s important to consider an appropriate balance of fees, state and federal income-tax savings as well as your return on investment. A great resource for all things college related is the website www.savingforcollege.com.
Stephanie Mackara is a Wealth Advisor at Charleston Investment Advisors. Charleston Investment Advisors is part of The Wealth Management Alliance LLC, a registered investment adviser. Though the contents of this article should not be construed as investment advice, feel free to reach out to Stephanie Mackara directly at firstname.lastname@example.org directly to discuss your specific financial situation.