How Should I Save For College?
If you are trying to save for your child’s education, you will find an array of investment vehicles available to you today. To determine which vehicle is best for you, you must consider the different features of each option. Two of those options, the Coverdell Education Savings Accounts (“ESA”) and the state-based 529 Plans are attractive plans that offer several unique and potentially beneficial college saving features. Both 529 and ESA plan assets can be used at any accredited college or university. For financial aid purposes, both of these vehicles are considered an asset of the parent if the owner is the parent or the dependent student and both also allow for a change in beneficiary to another family member. Additionally, both plans have similar tax treatment in that they allow for non-deductible contributions at the federal level, while withdrawn earnings are excluded from income to the extent they are used for qualified education expenses. However, only 529 plan contributions are deductible at the state level, but not in every state. A second difference is that 529 plans only consider higher education as qualified expenses, whereas ESA plans consider both K-12 education and higher education as qualified expenses. A third difference is the amount of the contribution. Only $2,000 per year per beneficiary is permitted to be contributed to an ESA plan, whereas 529 plans allow for dramatically higher contributions. One can make a $70,000 gift to a beneficiary with a five-year election, thereby removing the assets from one’s estate. A fourth difference is in the range of investment choices available. ESA plans are essentially a traditional brokerage account where almost any form of investment can be purchased. 529 plans are more limited in investment options and typically offer a set number of investment portfolios or mutual funds. The fifth difference is contribution eligibility. There is no income limit to contributions to a 529 plan. The ability to contribute to an ESA plan phases out for incomes between $190,000 and $220,000 (joint filers) or $95,000 and $110,000 (single filers). The last difference is that ESA plan contributions must be made before the beneficiary reaches the age of 18 and the account must be depleted by the age of 30. 529 plans have no time or age restrictions. Whether you choose to fund an ESA, a 529 plan or both, depends on your situation and what is important to you.
Another vehicle that can be used for college savings is what is known as a Private 529 plan. It sounds similar to the traditional state owned 529 plans, but it is actually very different. The Private 529 plan is a prepaid tuition plan. You put money into it today, and you lock in the current year’s rate for future years. With education expenses rising 878% since 1980, you would essentially be locking in a return equal to what the cost of college goes up each year until your child starts college. One caveat to the plan is that there are only a select number of schools (approximately 270) that participate in this plan. Click here to see a map of the participating schools.
Here is how a Private 529 plan works. Let’s say you have $100,000 available for college savings. When you invest in the Private 529 plan, you are locking in that year’s school rate for all the schools in the program. Two schools on the list that you might be familiar with are The University of Dayton as well as the University Of Notre Dame. What would the $100,000 get you at both schools? Given the 2016-17 tuition rates are $40,940 for UD and $47,929 for ND, you would essentially be locking in 2.44 years and 2.08 years at each school paid today – the money invested divided by the cost of school for that year.
A scenario we often discuss with clients is how grandparents can save in 529 plans for grandchildren. The savings into a 529 plan will not hurt the family or child’s ability to get need-based financial aid. None of the assets in the grandparents name for the benefit of the grandchild are counted against the family’s expected family contribution (“EFC”) – a term used in the financial aid world – initially. The assets do, however, get counted when the assets are distributed and the distribution is counted as “income” on the child’s FASFA form. Given this, consideration should be given to waiting until the child’s senior year to draw assets from the 529 plan, as such a distribution never would not get counted against the EFC.