College savings options

General discussion – A common goal to address once one’s own financial strategy is secure and in good order is to begin to help your kids or grandkids to invest in their future through savings earmarked to fund further education. The tough part to pin down is how and where to be saving for this goal? The base of this article will begin to address these questions and shed some light on the options and choices available.

Vehicles for college funding

Here are some college funding vehicles to consider:

529 Plans

These plans are advantageous for a variety of reasons.

The distributions of these accounts have to be used for room, board, tuition, books, and qualified educational expenses (which continue to evolve into a fairly comprehensive list).

529 plans are available on an individual basis per each state. These savings vehicles allow any individual (relative or non-relative) to fund the account at any point. The child may attend almost any two- or four-year college or a trade school.

The nice thing for most physicians is that 529 plans do not have income restrictions on who can utilize them.

You also can use any one state’s plan for any school in the country, so they are fairly flexible all around in that regard; however, you may lose out on certain tax advantages if you invest in a 529 Plan from a state in which you do not reside.

The dollars in a 529 plan grow tax-deferred and can be pulled out tax-free for the reasons mentioned above. If the withdrawals are not for a qualified educational expense, then any earnings will count as ordinary income at the account owner’s federal income tax rate and also subject to an additional 10% penalty.

The only ways to avoid the penalty is if the money is taken out due to a death, disability of the beneficiary, or if the costs were covered from the proceeds of a scholarship, timing of the scholarship, and withdrawal may be an issue.

The funds in the 529 plan themselves are typically managed by a fund family that has been previously set up by the state. Most fund families that run these plans often make age-based plans available or individual funds. The age-graded funds start off fairly aggressive in the investment mix when the child is young and eventually get more and more conservative in risk as the child approaches age 18. The individual fund options that are available allow you or your financial advisor to customize a portfolio based on your personal objectives and risk tolerance and can be tailored very specifically.

Individually constructed portfolios typically require a bit more monitoring throughout the accumulation phase. The account owner also has complete control over where and when the distributions occur, so the beneficiary does not have discretionary use of the funds.

Each state has its own specific 529 plan and a decent amount of states actually allow a certain amount of annual contributions to be written off against your state-specific tax liability. Please check your plan and work with a financial professional to determine whether or not your state plan offers this benefit.  Even if you do not like your specific state plan, you should consider the potential tax benefits it may provide over another state’s plan.

To find out if your state allows for a tax deduction or to research your investment options, I would recommend starting your research at savingforcollege.com. Ultimately though, I would recommend reaching out to a professional who is well versed in college funding for specific advice and investment education.

Uniform Transfer to Minors Act (UTMA) / Uniform Gift To Minors (UGMA)

Another popular savings tool for children is a UTMA or UGMA.

Annual gift tax limits apply to this (Currently a max of $14k from one person to another, so a set of parents or grandparents can transfer $28k to one individual gift tax-free). Although you can put almost any asset into a UTMA/UGMA, typically for college one would invest in mutual funds, stocks, or ETFs (Exchange Traded Funds). The nice part of a UTMA/UGMA is that the money does not have to be earmarked for anything in particular, as long as withdrawals are used for the benefit of the beneficiary.

Another upside to utilizing these accounts is the tax benefits on the growth of the account. In 2017, the first $1050 of investment income is tax-free. The second $950 of growth in an account is taxed at the child’s income tax rate. Any investment growth beyond $2100 per year is then taxed at the parent’s marginal tax rate.

The potential downside of funding these accounts is that the child has complete control over these funds when they reach the age of majority, which can range from 18-25, but most often 21. Age of majority varies by state. You should check with your financial professional to determine if the minor has reached the age of majority in your state.

The main difference potentially between a UTMA and UGMA is that the termination age may vary from state to state (commonly 21 for UTMA and 18 for UGMA, but please consult specific state legal guidelines) and that a UGMA may restrict the types of assets that transfer and be slightly more restrictive on usage, which typically leads most advisors to lean towards the UTMA vs. UGMA.

Coverdell ESA

Similarly to a 529, the funds that the plan are allowed to grow tax-deferred and come out tax-free when used for qualified education expenses.

A potential downside of these accounts is that the assets must be used by the age of 30 and contributions must not be made past age 18. Unfortunately, you are also phased out of a Coverdell plan in a phase income range of MAGI from $190k-$220k for Married Filing Jointly and contributions are limited up to $2k/yr.

An upside to this plan is that you can use these savings to pay for k-12 expenses as well (as opposed to 529s that have to be used for post-high school education.

Other considerations

Non-qualified brokerage accounts

Of course, any savings is good savings at the end of the day and one could always save money in an independent brokerage account. This would be an account that you have in your name and complete control over. You can choose your investments to be any stock, bond or mutual fund out there and can manage the risk to suit your tolerance and time horizon for the use of the funds. The downside is that you will be subject to paying capital gains tax on any realized gains.

Grants/Scholarships

These are mechanisms for aid that do not need to be paid back. Traditionally grants are need-based while scholarships are merit-based, but this is not always the case.

The world of options here is vast, and I would recommend starting with exploring the institution’s specific options. For resources outside of the institution, you can look for assistance from the federal govt, state govt, private and non-profit organizations as well. Here are a few resources for to potentially help further in this area:

1. https://www.scholarships.com/financial-aid/college-scholarships/scholarship-information/college-scholarships-and-grants/
2. https://www.salliemae.com/college-planning/financial-aid/understand-college-grants/
3. http://www.collegescholarships.org/grants/

Outside loans

Many banks are now surfacing in this low-interest rate environment outside of traditional government lending. It is important if seeking financing of tuition and expenses through loans to comb through both private loan options in addition to the traditional government lending options.

Cash Value Life Insurance

Using life insurance as an accumulation tool can also be an advantageous way to accumulate assets to fund for college.

There is quite a bit of detail that you would need to learn about the inner workings of properly structuring a policy of this nature, but the main advantage is that a portion of the life insurance premium goes into the cash value of a life contract and potentially grows tax-deferred. This cash value can be loaned from the policy without the potential of incurring income tax consequences.

The downside to using these is that you typically have to pre-fund the true life insurance costs in the first few years which pushes the breakeven point of the initial costs to the benefit of the tax deferral and compounding of the investments a significant amount of time in to the future, which requires some foresight to plan far enough ahead to make this vehicle’s structure worth it.

This vehicle wouldn’t be my first pick by any means for the majority of people saving for college, but it is an option depending on goals and other personal financial circumstances. Structure of policies are key to even make it a potential option and policy loans and withdrawals may create an adverse tax result in the event of a lapse or policy surrender and will reduce both the cash value and death benefit.

Depending upon actual policy experience, the Owner may need to increase premium payments to keep the policy in force. Please keep in mind that the primary reason to purchase a life insurance product is the death benefit.

Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender periods. Policyholders could lose money in this product.

The rising cost of college

Once you know what vehicle(s) are best suited for your college savings goals, then it becomes a matter of how much to save.

This can be a fairly tricky number to pin down for a young child with so much time to pass yet before the money will be used, but a few trends should be noticed.

The average cost to attend ALL types of colleges is rising higher than inflation rates year after year. The cost of attending a four-year public university rose roughly 160% last decade where the average tuition was $8653/yr in 2000 and closed at an average of  $15,014/yr during the ’09-’10 academic year private four-year schools in ’00 were averaged at $21,856 whereas they too took a sizeable jump to average at  $32,790/yr at the close of the decade as well (source: National Center for Education Statistics: https://nces.ed.gov/).

Savingforcollege.com sites that the 10-year historical rate of increase as of 2011 for college tuition was 6%.  If this rate were to continue into the future, the Rule of 72 (http://www.investopedia.com/terms/r/ruleof72.asp#axzz23ix6Y9NY) would suggest total costs could double every 12 years!