Planning for their future refers to your children and grandchildren. The most common financial planning goal for “their future” is funding college. As tuition costs have been rising at a faster rate than inflation, the challenges of paying for college have also increased. Tuition increases have stabilized in recent years (CollegeBoard’s Trends in Higher Education), but the price tag is still steep with state colleges averaging $9,139 per year for in-state students, $22,223 for out-of-state students and $30,000 for private universities. These are just tuition costs and do not include covering room and board.
Once you decide how much of the college bill you are willing and able to fund for your child or grandchild, there are a variety of savings vehicles available. While you could just use a regular taxable savings or brokerage account, you would be missing out on significant tax savings. For example, in a Coverdell Education Savings Account (ESA) or a 529 Plan, contributions grow tax-free and the funds are not taxed when distributed as long as they are used for qualified educational expenses. Traditional and Roth IRAs can also be used as tax-sheltered strategies for funding college, but there are many IRS rules surrounding how the funds can be contributed and withdrawn and you still have to pay taxes on the withdrawals in a traditional IRA and on the excess distributions from the Roth IRA. These are just a few of the methods available to fund college and each type of account has their own unique features.
The most popular savings vehicle for college funding is the 529 Plan. A 529 Plan is a college savings plan operated by a state or educational institution specifically for funding future college costs. 529 Plans are popular because you can contribute more than other savings vehicles, in addition to the tax-free growth and distributions for qualified education expenses. In a 529 plan, you can actually forward fund the plan with your annual gifting exclusion for the next five years (see our recent blog entitled “The Spirit of Giving – Ways to Give Without Giving to the IRS” for a refresher). Forward funding in 2015 would equal $70,000 to set aside for each child per parent.
A small advantage to an ESA is that it can be used for both pre and post-secondary education, while 529 plans can only be used for post-secondary education. However, the maximum amount that can be contributed to an ESA each year is $2000 per beneficiary. The maximum contribution to a Traditional IRA or Roth IRA is $5,500 for 2015. It is a good idea to consult with your tax professional about all of the rules surrounding IRA contributions and distributions for education expenses.
The other side of college planning is financial aid. For each year of college, students (and their parents) will have to file the Free Application for Federal Student Aid in order to seek eligibility for financial aid. The dreaded FAFSA. This application determines the Expected Family Contribution (EFC) to a student’s college education (this is not necessarily the amount the family will actually pay for college) and schools use this information to determine how much need-based aid they will offer to a student. The EFC is calculated based on the family’s income, assets, family size, etc. Assets owned by the child are counted directly towards the EFC, while assets owned by the parent are calculated at a % and some parental assets are not included. As a result, the way assets are titled – who owns the account or asset- is very important when determining the EFC.
There are several variables to consider when planning for college. How much to save based on what you want to fund, which savings vehicle(s) to use, and who will own the account. We regularly assist our clients with navigating these questions and establishing a college funding plan. There are also several web resources available to the public, such as the BigFuture website by the CollegeBoard or College Results Online that can help you get started.
Associate Financial Planner