Coaching Clients on the Rising Cost of College
Only the cost of fuel oil and gasoline has risen more than the cost of college tuition over the past 10 years, rising a staggering 88 percent since 2003.¹ Meanwhile, the value of a college degree has likely never been higher. The average person with a bachelor’s degree will earn 80 percent more than a high school graduate during a 40-year career, according to a column in The Dallas Morning News. That’s a lifetime difference of more than $500,000.
As higher education tuition costs continue to rise, saving for college is becoming increasingly difficult for many American families. Most parents know they need to put money aside for their children’s education, but they don’t make it a priority when it comes to evaluating their family’s financial future.
One of the biggest issues I see is that people have trouble trying to juggle saving for retirement and saving for college, while maintaining their desired standard of living. It’s important to prioritize saving for retirement first and saving for college second. Budgeting for both can be difficult, but it’s crucial to remain disciplined when it comes to your savings plans.
In order to start saving for college properly, clients first need to determine the amount they’ll need to save. There are many calculators available to help estimate the cost of a sending a child to college. For example, a one-year-old child will require savings of roughly $295,000 by the time he or she reaches college years to cover the cost of a four-year university education. This is assuming a 6 percent annual increase in college costs based on estimates from a calculator at SavingforCollege.com.
However, wealth advisors shouldn’t just rely on calculators. It’s important for advisors to speak in-depth with their clients about how they can calculate the appropriate amount they will need to adequately save for their child or children’s college. There are a number of factors to consider, including tuition, room and board, textbooks, supplies, spending money and more.
Calculating how much is needed is just the first step; you’ll then need to work with your clients to identify a savings plan or account that works best for them. There are many ways to save, but here are some of the most popular options your clients can consider.
529 College Savings Plan
A 529 college savings plan is a program that was developed to help people save for future college expenses, while providing substantial tax benefits. When it’s time for the student to head off to college, the account principal can withdraw the assets for qualified higher education expenses, such as tuition, fees, books, required equipment or certain room and board costs. The funds are withdrawn tax free.
Another big advantage of 529 plans is that they have the highest contribution limit among all college saving plans. Single individual clients can contribute $13,000 per year or $26,000 if they’re married (and filing jointly) without having to pay a gift tax. 529 plans also allow for other family members, such as grandparents, to contribute.
Clients can also take advantage of accelerated giving, in which the plan will allow a client to make up to five years' worth of gifts ($65,000 if single/$130,000 if married) to a 529 plan account beneficiary in one year without incurring gift taxes.
529 plans can also potentially provide both federal and state tax benefits. While your contributions cannot be deducted on your federal tax return, your investment grows tax-deferred and the distributions paid out to a beneficiary for educational costs are tax free. For states with an income tax, there could potentially be some tax benefits for making a contribution, as well.
There are some fees worth noting for 529 plans. Some plans may charge enrollment and administrative fees. Others may charge annual maintenance and asset management fees. It’s important to discuss these fees with clients, as they have the potential to affect returns. Another key point is that asset level a potential student has in a 529 plan can reduce their potential to receive financial aid.
Lastly, 529 plans provide the donor with a great deal of control. If the intended beneficiary of the plan decides not to go to college, then they can change the beneficiary to a different family member, such as another child, a spouse, parent, niece or nephew, etc. While transferrable, there are limitations to how the money can be spent. Non-educational expenses will likely incur taxes and other penalties.
For more resources on 529 Plans, visit the following:
Coverdell Education Savings Accounts (ESAs)
After a period of uncertainty, Coverdell ESAs, formerly known as Education IRAs, have regained some popularity since contribution limits were made permanent in the American Taxpayer Relief Act of 2012. Coverdell ESAs differ from a 529 plan in that these plans can be used for education expenses for someone attending a private elementary or high school, not just college. Secondly, the total contributions for the beneficiary of this account cannot exceed $2,000 in a given year. A beneficiary is defined as someone who is under the age of 18.
Contributions to a Coverdell ESA are not tax deductible, but amounts deposited in the account grow tax free until they are distributed. The beneficiary will not owe taxes on the distribution(s) as long as the amount is less than his or her qualified education expenses at an eligible institution.
The account must be fully withdrawn by the time the beneficiary reaches age 30, or else it will be subject to tax and penalties.
For more resources on Coverdell ESAs, visit the following:
UGMA (Uniform Gift to Minors Act) and UTMA (Uniform Transfer to Minors Act) accounts have been around for years. Long before the time of 529 plans or Coverdell ESAs, parents relied on these accounts to save large amounts of money to put toward their children’s college expenses. Like 529 plans, the donor doesn’t have to be a member of the beneficiary's immediate family; others, such as grandparents, can contribute to a UGMA/UTMA.
UGMA/UTMAs are custodial accounts designated for a specific beneficiary. The beneficiary cannot be changed on these accounts – once a beneficiary has been identified, the funds must be distributed to that person. Different from 529 plans and Coverdell ESAs, the beneficiary can choose how the money is used. It does not need to be put towards education. Because the assets are considered the property of the minor, these accounts are often used to take advantage of the “kiddie tax.” The kiddie tax allows a certain amount of a minor’s income to go untaxed, and an equal amount to be taxed at the child’s tax rate (as opposed to Mom and Dad’s rate).
Individual Retirement Accounts (IRAs)
IRAs are traditionally used as retirement accounts, but they are also an option for people who are saving for both retirement and college. An individual can put money into an IRA and then make a withdrawal for qualified higher education expenses (tuition, fees, books, supplies, etc.).
IRAs can be used to pay for college as long as the distributions are not more than the individual’s qualified higher education expense. This is one of a handful of exceptions for individuals wanting to make a penalty-free withdrawal from an IRA before the age of 59 ½.
IRAs have other benefits as well. Just like the government sponsored college savings plans, IRAs also provide great income tax benefits. As long as the taxpayer qualifies, the account grows either tax-free or tax-deferred. Secondly, assets in an IRA will always remain in the name of the person who opened the account. So, if your child decides that he or she doesn't want to attend college, then you can put the funds towards your retirement.
Discussing Education Planning With Clients
As a CPA or wealth advisor, it is important to know the income limits that may restrict certain clients from utilizing one of these college savings strategies. You can always begin the conversation by highlighting several things to keep in mind when saving for college. Start saving as early as possible and be disciplined.
The sooner they get started, the more time they will have to accumulate assets and they will have a much higher chance of reaching their education planning goal. Help the client determine the amount they would reasonably be able to set aside each year based on their current income and guide them on ways they can try to increase their contribution each year. If they get discouraged because they haven’t saved enough to cover the full cost, remind them that any savings will help reduce the burden of paying for college.
With the complexity surrounding rising college expenses and the number of savings options out there, the more a CPA or wealth advisor can educate themselves now, the better chance they have in helping their clients honor the important promises they’ve made to the ones they love.
Craig Johnson is the supervising director for 1st Global’s Financial Consulting Group. The Financial Consulting Group partners with 1st Global firms to assist in building, developing and maintaining successful wealth management practices.
Please consider, before investing, whether your home state offers any state tax or other benefits that are only available for investments in your state’s qualified tuition program. Other benefits may include reduced or waived program fees, matching grants, and scholarships to state colleges. Any state-based benefit offered with respect to a particular 529 college savings plan should be one of many appropriately weighted factors to be considered in making an investment decision. You should consult with your financial, tax or other adviser to learn more about how state-based benefits (including any limitations) would apply to your specific circumstances and you also may wish to contact your home state or any other 529 college savings plan to learn more about the features, benefits and limitations of that state’s 529 college savings plan.
Qualified expenses include tuition, fees, room and board, books and other supplies needed to attend an institution of higher education. A 10% federal penalty on earnings will apply if you receive a non-qualified withdrawal.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame logo), which it awards to individuals who successfully complete initial and ongoing certification requirements.
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¹ “10 Items Whose Prices Have Jumped the Most in the Past 10 Years,” http://finance.yahoo.com June 6, 2013.