Monday, January 13, 2014
With another class of high school seniors graduating, parents across the nation are bracing for some very expensive years ahead. The cost of higher education continues to present a formidable financial challenge for many families, but for those who are able to set aside funds when their kids are still in primary school (or sooner), the power of compounding growth over time can substantially ease the burden. And with tax-favored ways to save for post-secondary education, this compounding growth can occur within a tax-deferred account.
The gold standard for those wishing to save for higher education is the 529 Plan. A 529 Plan is an education savings plan operated by a state or educational institution designed to help families set aside funds for future college costs. It is named after Section 529 of the Internal Revenue Code which created these types of savings plans in 1996. Contributions to these plans don’t result in any Federal income tax deduction (although some states offer tax benefits for contributions), but contributions grow tax-deferred, and if the funds are ultimately used for higher education costs (technical school, community college, four-year university, graduate school, etc.), the distributions are entirely tax-free.
The plans are usually established and owned by a parent or grandparent, with the student listed as the beneficiary of the plan. Because each state sponsors its own plan, selecting the right plan can feel a bit daunting. We first recommend determining whether your state offers a tax deduction for contributions to its plan. If so, it often makes sense to go with that plan. If not, selecting a plan with low internal costs and a broad array of investment choices is preferred. The Utah Education Savings Plan (UESP) is one of our top choices. A great resource for researching plans is: www.savingforcollege.com
Once the beneficiary is ready to enter college, the funds within the 529 Plan can be used for a wide variety of expenses, including tuition, fees, books, supplies and equipment. For students who are pursuing a degree on at least a half-time basis, a limited amount of room and board is also considered an eligible expense.
Although starting early and leveraging the benefits of tax-free growth is the ideal scenario, many families with older children have not yet begun to save for college. For those parents who still wish to support their children in college, either in full or in part, other options to consider are tapping personal brokerage account balances, opening a home equity line of credit (HELOC) to borrow against home equity, setting up a monthly tuition payment plan and paying out of cash flow, or some combination of these options. There’s always the possibility that kids will receive scholarships or other financial aid (merit or need-based) as well. What we do not advise, however, is paying for college expenses if it means jeopardizing the retirement and financial security of the parents. This may seem obvious, but many well-intentioned parents often miscalculate the impact of paying college expenses on their ability to ultimately retire.
Entering college is a big step for kids and their families. With proper planning, either in advance or in real time, the cost of college can be managed with both the parents’ and kids’ financial futures in mind.