When it comes to paying for college, we generally see three distinct points of view from our client families. Some come in and say, “Hey, I paid for my college by working and saving, so my kids should do the same.” Others take a similar approach but offer a reward of some kind, whether help with a down payment on a home or assistance paying for graduate school, once the child has worked his or her way through school. The third approach we see are the parents and grandparents who want to pay for all aspects of their children’s college, either because their parents didn’t or couldn’t pay for theirs and they remember how tough that was, or because their parents did and they want to do the same thing for their kids.
Whatever your reasons for wanting to start a college savings plan, several questions arise over and over again as we meet with our client families.
1. How much do I need to save? This of course depends on where your child plans to go to school and how many children or grandchildren you have. Variables such as in-state or out-of-state tuition, private versus public universities, and whether or not your child is able to earn any merit- or needs-based scholarships will affect how much you’ll need to sock away for school expenses. We can sit down with you, take a look at your individual situation and help you calculate a target amount to work towards.
Believe it or not, one of the biggest concerns we hear from clients about college savings is the fear that they’ll save too much. Let me tell you something – in my two decades in this business, I have only seen two cases in which there was money left over when a child finished school, and in both families, there was either a younger sibling headed for college, or an advanced degree that needed to be paid for. The most important thing I can say is, don’t ever let the fear of saving too much keep you from starting to save in the first place!
2. What is the best savings plan for me? The savings option most of our clients choose is the 529 college savings plan. These plans allow contributions of up to $16,000 annually without gift-tax consequences. Much like a Roth IRA, any growth in the plan is tax-free, provided the money is used for college and college-related expenses.
Another less popular option are pre-paid plans offered by state or educational institution. However, in recent years, fewer and fewer states are offering these options as asset growth was not strong enough to keep up with the rising costs of higher education. At Family Financial Partners, we have found that most of our clients want more control over how their money is invested, and so they pick the 529 plan.
3. Are there tax benefits to saving for college? Every state is different and some do provide state income tax incentives when saving for college. As it happens, Kentucky does not offer any income tax breaks to college savers, but in reality, any state tax breaks are small and therefore not something to worry about on small sums of money. The real tax benefit comes when those 529 funds are used – any growth over the years of investing is taken out tax-free, provided the money is spent on education, room, board and other related expenses. So if you invest $10,000 and over the years that grows to $100,000, that $90,000 of growth will not be taxed.
4. How should I invest my 529 college savings plan? Just as with a 401(k), we advise our clients to either fund their college plans with lump sums 1-2 times per year (think work bonuses or tax refunds), or treat it like any other bill and automate the payments on a monthly basis. We see over and over that clients who automate tend to stick with their plans through thick and thin. And remember, you can fund your 529 plan with as little as $50 a month – start small and work your way up.
Most 529 plans are set up with mutual funds which can be age-based and adjusted to be less aggressive as the child gets nearer to college age. We typically recommend to our clients that they pick a basket of mutual funds that allow us to dial up or down the risk, just as we do with their other accounts.
5. Why shouldn’t I just set up a joint bank account with my child? The problem with this approach is that eventually your child becomes an adult, and could take that money and use it for anything. A joint account only requires one signature for withdrawal. Even if you’re sure little Johnny or Susie would never use college money for a shiny new sports car, 529 plans take away any temptation to blow that money on something other than school. The beneficiary (in this case the child) has no rights to the funds, and you can actually reclaim the money as the account owner.
6. I have four children. How many accounts do I need? If you’re only funding the account up to the annual limit, open a 529 plan in your oldest child’s name and keep it simple with just one account. Any blood relative (even foster or adopted children) can use the money for their school. If grandparents and other relatives are helping to fund the account in amounts upwards of the special election limit, then you’ll need more than one account. Give us a call and we can help structure a plan for your family that involves as little tedious paperwork as possible.
What questions do you have about saving for college that we didn’t address here? Give us a call and let us know. We’re always here to help. And as always, if you know someone who might benefit from setting up a college savings strategy, be sure to pass our name along.
Article by David Smyth, Senior Partner at Family Financial Partners — a financial services firm in Lexington, Kentucky.
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