BMO Family Office
The value of a higher education has never been more evident. College graduates earn nearly two thirds more over the course of their careers than people with only a high school education, according to the College Board.
Yet paying for higher education is becoming increasingly harder. The College Board reports that annual tuition, room and board and fees at a public four-year college now average $21,370. The tab comes to $48,510 at private universities. To deal with the rising expense, families are increasingly leaning on student loans, with the average borrower owing over $39,000 at graduation.
But saving for college is an imprecise science. “You don’t know the exact cost you’re saving for or which college your child will go to or whether or not your child may get grants or financial aid,” says Steve Williams, Senior Vice President, Head of Financial Planning, U.S., BMO Private Bank.
Despite the unknowns, planning is crucial. By getting a handle on the available college savings vehicles and how they work, you can make a big dent in your child’s education cost—and help them avoid debilitating debt.
The earlier the better
If you have small children, it might be hard to imagine that one day they’ll be college bound. But it won’t be long before your little bundle is picking out her college courses and meeting her roommate. Time is of the essence.
“The birth of the child is always a great time to set up the 529 account,” says Williams. “That 18 years goes fast and the longer the account has to grow, the better.”
The earlier you start, the easier the task will be and the less you’ll need to save.
“Funding half of the college cost can be a reasonable goal if you start early and invest $3,000 to $5,000 each year,” Williams says.
In fact, after taking into account need-based financial aid, scholarships and grants, the net cost of college—what families actually pay—is only $14,800 and $27,290 a year at public four-year schools and private colleges, respectively.
A 529 has tax breaks and flexibility
The 529 has earned a deserving reputation as the go-to vehicle for college savings. The plans are flexible and loaded with tax benefits.
While you won’t get a federal tax deduction for your 529 contribution, the money grows tax free. And if it’s used for qualifying educational expenses (which go well beyond just tuition),
then the money can be withdrawn tax and penalty free. What’s more, you might get a full or partial state tax deduction if you invest in your state’s plan (though you are free to choose a plan from another state if you prefer those investment options).
Because college costs rise at about twice the rate of general inflation, choosing investments with more growth potential, like stocks, can help your college savings outpace inflation. Most 529s include a target-date allocation fund option, which starts with a large portion of assets invested in equities. As college nears, the portfolios reduce their equity positions in favor of fixed income holdings which have less volatility. This allows you a simple, one-stop investment.
Many plans also include a menu of different funds so you can design your own portfolio if you want a more hands-on approach.
A useful estate planning tool
Saving for college doesn’t have to be your burden alone. If grandparents are eager to make gifts to your children, encourage them to contribute to the 529 plan as well.
“Instead of buying toys for Christmas, putting money towards college has a much greater long-term impact,” notes Williams.
A 529 can also reduce an estate—and possibly estate taxes. The accounts can be funded through gifting, with the annual gift exclusion now being $15,000 per individual. Because each spouse can make a gift, a child could potentially receive $30,000 annually in gifting from grandparents. Better yet, 529s allow the ability to bunch five years’ worth of contributions, so each grandparent can give up to $75,000 at once.
One note of caution about grandparents and 529s, Williams points out.
“Having grandparents as the plan owners can have a more negative impact for financial aid than if the parent were the plan owner.”
The reason? While a grandparent-owned 529 doesn’t get reported on need-based financial aid forms, withdrawals from the account are considered to be income to the student, which does need to be reported. That can adversely affect a financial aid award.
“If the grandparent owns the plan, the distribution can reduce need-based aid by as much as 50%,” Williams explains.
529s that are owned by the parents, on the other hand, reduce eligibility for need-based aid by up to 5.64% of the asset value. But distributions are not considered student income.
What to do with money left over?
Maybe your daughter is an athletic star or a musical virtuoso and lands a full scholarship. Perhaps your son decides to forgo college. That raises the dilemma: what can you do with money that’s left over. There are several options to consider:
• New beneficiary: Transfer the account to another child in your family.
• Grad school: Your child might encounter other educational expenses down the road.
• Pass it on: Hold on to the account and pay for a grandchild to go to college.
• Educate yourself: Use the money to further your own education.
• Use it: Only earnings are taxed and carry a penalty, but withdrawals of your own contribution are not.
New rules to consider
During the tax overhaul at the end of 2017, 529s underwent some changes. Now, parents can use up to $10,000 a year from the 529 account to pay for K-12 tuition. If you plan to use a 529 to fund private school, consider setting up the account even earlier—before the birth of a child.
“With the flexibility of naming the beneficiary, a 529 account could be set up in one parent’s name then the beneficiary can be changed to the child,” Williams says.
As the economy becomes ever more sophisticated, the value of a college education can’t be overstated. At the same time, college costs continue to rise, straining family finances. Hopefully your children will earn themselves scholarships and grants to reduce the college bill. Do your part by making college savings a priority early on and using a 529 plan to save on taxes.
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