Choose the right vehicle to drive college savings planning
If you have watched the news lately, you may have noticed that saving and paying for college tuition is a stressful part of the American experience.
Since the jury is still out on whether leveraging the public debt to pay for private fragility (2008 banks, auto companies, airlines, and student loans) will join baseball as America’s favorite pastime, it pays dividends to review the available college savings vehicles and how they fit into your financial plan.
When discussing 529 plans, it is important to distinguish between prepaid and savings plans.
A 529 prepaid tuition plan, such as Washington’s GET (Guaranteed Education Tuition) program, allows you to buy future tuition “units” at current tuition prices.
As a theoretical example, let’s say a single class is worth five units and the cost is $1,000 today for those units.
In 10 years, your child or grandchild goes to Washington State University and a five-unit class costs $2,000 due to rising tuition. With a 529 prepaid plan, that doesn’t matter because the class is measured in units which you had purchased years ago.
Therein the benefit lies: your GET account is guaranteed to keep pace with tuition and state-mandated fees at Washington’s highest priced public university.
GET funds also can be used to pay tuition in other states or at private universities but the credit value is still tied to the fees of Washington’s highest priced public university.
529 education savings plans are the most common of the 529 family, where contributions grow tax deferred and withdrawals are tax-free if used for qualifying educational expenses.
The key difference between the savings plan and a prepaid tuition plan is the investment risk of the former.
Savings plans attempt to harness the power of the stock market to grow at a faster rate than college tuition and aren’t anchored to public universities as a prepaid plan is.
Investments always carry risk, and most plans offer target-date funds which shift their assets each year by becoming more conservative as the beneficiary gets closer to college age.
Coverdell education savings account, or ESAs, exist but are rarely used due to contribution and income limitations.
With a Coverdell ESA you can only contribute a maximum of $2,000 a year and to contribute the full $2,000 your modified adjusted gross income must be below $95,000 for single filers and below $190,000 for joint filers.
Uniform Gifts to Minors Act, or UGMA, and Uniform Transfers to Minors Act, or UTMA, accounts are taxable accounts for the benefit of a minor.
Whether these accounts make sense as a college savings vehicle depends on an individual’s financial plan.
On the one hand, they provide great optionality. On the other hand, gains are taxed upon stock liquidation, interest may be subject to taxation, and assets in a student’s name are counted more heavily against financial aid than assets held in a parent’s name.
Contributions from grandparents
They say it takes a village to raise a child, and college planning isn’t any different.
Whether it’s feeling of joy brought by seeing their grandchildren attend a university or an estate tax planning strategy, grandparents can play a role.
They can set up 529 plans and custodial accounts with their grandchildren as beneficiaries.
If they plan to rely on financial aid, however, both accounts can hinder a student.
Assets held in the name of the student, such as the custodial account, can result in less financial aid being granted to the student.
In the case of a grandparent 529 plan, though the asset is not reported on the Free Application for Federal Student Aid, or FAFSA, the distributions from the 529 must be reported as untaxed student income.
Unearned student income can reduce financial aid by as much as 50% of the cash support provided. For example, if you took a distribution of $5,000 from a 529 plan to help pay for college, it could reduce financial aid for the student by $2,500.
One way to get around this concern would be to contribute to the parent-owned 529 instead of setting up a separate plan.
There has been talk of eliminating the FAFSA requirement for reporting cash support, which would eliminate the concern of cash support reducing financial support but reporting requirements have not changed as of this writing.
These contributions also can be part of an estate planning strategy.
Contributions to a 529 plan up to $16,000 per beneficiary qualify for annual gift tax exclusions.
Married grandparents can contribute up to $32,000 to a grandchild’s 529 or custodial account per year and it would not be included in their taxable estate.
Furthermore, the $16,000 gifted per grandparent will not count against their lifetime gift-tax exemption. Grandparents can actually contribute up to five years’ worth of the annual gift exclusion into a 529 in a single year but they need to file an extra form with their tax return if they choose to do so.
It is not a savings vehicle, but I’d be remiss to not include military service as a way of paying for college. Enlisting and using the GI Bill, attending a service academy, or joining ROTC are all excellent ways to serve your country, meet wonderful people and get an education.
Just remember that there are strings attached and military service is a serious commitment. Furthermore, if your parents or grandparents were kind enough to contribute to a custodial account as you were growing up, you can graduate debt-free with a handsome asset that will continue to grow.
College planning isn’t as complicated as NASA’s Artemis I mission, but its significance and cost can be intimidating. Thankfully, plenty of people who have gone through a similar ordeal are happy to share their opinions. Just make sure they are qualified opinions.
Nicholas Haberling is a partnership advisor at Community First Bank & HFG Trust in Kennewick.