Summer is here, and it is time to load up the car to hit the beach and have some fun. The economy is opening up, and demand for travel has been pent-up for what seems like an eternity. Families are gathering again, pandemic-canceled trips are being rescheduled, and vacation dreams conceived in lockdown are being realized. Before you know it, the kids will be back in school… in person (Parents rejoice!). Now is a great time of year to reevaluate your college saving goals for your children, grandchildren, or other family members.
Putting children through college can be one of the largest expenses families will ever encounter. We all want what is best for our kids, but how do we balance saving for their education while at the same time keeping our retirement savings on track? It can be a daunting task to stare in the face but having a plan will help you succeed, and we are here to guide you!
Daunting College Costs
College tuition costs continue to rise across the country at a pace higher than the regular inflation rate. The total cost of college goes beyond just the tuition bill for your student. You also have to factor in books and supplies, travel to and from home, other miscellaneous expenses, and the big variable of student room and board. Whether the student lives on campus or in an off-campus apartment can have a big impact on a student’s overall costs. According to the College Board’s Trends in Pricing for 2020-2021, the average all-in price per year for a four-year in-state public college is $26,820, four years for an out-of-state public college $43,280, and the costs of a private college would be $54,800. In the Bay Area, the current cost of Cal Berkley (in-state) is $42,515, while Stanford comes in at a robust $76,928 per year all-in. As you can see, four years of college will add up to a substantial total expense for each child. Educating yourself on college costs and knowing your options can help you prepare.
The Right Fit
Whether the future student is your child or grandchild, involve them in the saving process, so they understand where the potential budget falls. Choosing a school that matches what the student wants and that fits the budget is an important part of planning. Consider all the costs, including how many years it will take to graduate, both potential merit-based and need-based scholarships, and other funding sources. You have to remember that colleges are big businesses, and they are very good at what they do in making their campus and school very desirable. Do your homework in advance, so you pick the school that is the best fit for your student and your budget.
What Are the Options for Saving for College?
UGMA/UTMA – A Uniform Gifts to Minor Account/Uniform Transfer to Minor Account is a bank or brokerage account with an adult custodian that is owned by a minor. Parents and Grandparents can gift money in this account as a way for a child to save for college. Taxes are paid at the parents’ rate after the first $2,200 of unearned income. The first $1,100 is tax-free, the next $1,100 is taxed at the minor’s rate. One downside of these accounts is the minor gets control of the funds when they become an adult, so they can use the money for something other than college or educational purposes. There is also limited tax benefit to a UGMA/UTMA.
Coverdell Education Savings Account (ESA) – A Coverdell ESA is an education funding tool that offers tax-free earning growth with tax-free withdrawals when the funds are spent on qualified education expenses. Qualified educational expenses include tuition, books, fees, supplies, computers, and sometimes room and board. A Coverdell has some limitations: You can only deposit up to $2,000 a year into the account and the contributions must stop when the beneficiary reaches age 18. In addition, all the funds must be spent by age 30. Coverdell contributions are also limited by contributor’s income, with phaseout between $95,000 to $110,000 for single taxpayers and $190,000 to $220,000 for married filing jointly. The maximum total of $2,000 is across all Coverdell Accounts for the student, so family members will have to coordinate if multiple people are saving for a student’s education.
One advantage of the ESA is that it can be used for many K-12 expenses, including tuition, books, supplies, uniforms and even room and board. The Coverdell Education Savings Account is similar to your brokerage account in that it can hold stocks, bonds, and mutual funds. Contributions to Coverdell are similar to an IRA in that they must be made by tax day, April 15th. There is no tax deduction for contributions made to a Coverdell Account.
One of our advisors recently had a client meeting with a Grandmother and her 18-year-old granddaughter getting ready to set off for her first year of college. At the meeting, Grandma shared with her granddaughter that she had been putting $2,000 a year into a Coverdell every year since she was born. That $36,000 in deposits were invested every year and had grown significantly – enough to fund most of her expected college costs. A very happy celebration followed thanks to a well-executed savings plan.
529 College Savings Plan – One of the most popular savings vehicles for college is a 529 college savings plan. They invest only in mutual funds, with the fund options being determined by which state plan you choose. You don’t need to invest in the state plan where you reside; compare the state plans to see which is the best fit for you – contact us and we will guide you! There are no annual contribution limits on a 529 plan, however, there are aggregate contribution limits. Contributions to a 529 plan count as gifts for gift-tax purposes. The current annual gift tax exclusion stands at $15,000 per beneficiary ($30,000 for gifts from a married couple). There are also no income restrictions for contributions. Both parents and grandparents can open accounts for the same beneficiary.
The 529 plan also allows a donor to make five years of donations lumped into one $75,000 lump sum contribution. This can be a good estate planning tool as the $75,000 is outside of the donor’s estate, but they still are in control of the assets. The 529 plan is an investment account that lets the donor control the funds while keeping them in their own name. With few exceptions, the named beneficiary has no legal rights to the funds, unlike a UGMA/UTMA where the child takes control of the assets once they reach legal age. If the child named beneficiary chooses not to go to college, you can repurpose the money.
Similar to a Coverdell Account, in a 529, assets grow tax-free and the withdrawals on qualified expenses are tax-free. If the money is used for some other purpose, the earnings are taxed as ordinary income and there is a 10% penalty. The 529 has the flexibility of changing the beneficiary within the family with no penalty if the student decided not to attend college. Parents can name themselves the beneficiary if there is money left over to take classes.
Legislation has been passed over the last couple of years that has enhanced some of the capabilities of a 529 plan which is beneficial for parents and grandparents that are looking to save for college. The Tax Cuts and Jobs Act of 2017 allows up to $10,000 a year per beneficiary to pay for K-12 tuition expenses (residents of California will have to pay a 2.5% state penalty tax on earnings used for K-12 tuition). Unlike the Coverdell Savings Account, the 529 Account can’t be used for other K-12 expenses. The SECURE Act passed in 2019 opened the door for student loan repayments up to $10,000 per borrower (lifetime limit) for the beneficiary of a 529. Some states, California included, do not conform with federal law; check with your state before taking a disbursement to pay-off student loan debt.
Changes to Grandparents 529 Plan Rules
With the updated Free Application for Federal Student Aid (FAFSA), the amount of student’s “total income,” which includes untaxed income, will come directly from the federal income tax returns via the IRS Data Retrieval Tool (DRT). This means students do not have to report a distribution that was taken from a grandparent’s 529 plan beginning next year, 2022 school year. Prior to the new rules, the student would report the 2022 distribution as untaxed income on the 2024-25 FAFSA. 529 plans owned by a grandparent are not reported as assets on the FAFSA either. The grandparent’s 529 plans are still considered on the CSS Profile, which is an additional financial aid form used by some private colleges.
Are 529 Plan Contributions Tax-Deductible?
Currently, 529 contributions are not tax-deductible at the federal level. Over 30 states and the District of Columbia offer state income tax deductions or tax credits for contributions to a 529 plan. Unfortunately, California is one of the states that does not offer a tax deduction for contributions to a 529. Tax-free growth is still a key benefit of 529 Accounts.
529 Prepaid Tuition Plans
Another option for college savings is a 529 Prepaid Tuition Plan that allows for pre-payment for some or all of the costs of an in-state public college. The price of the tuition is locked in at today’s prices at participating institutions.
Loans: Federal vs Private?
If you don’t have enough saved to meet your college student’s expenses, loans are available to help bridge the gap. Many parents feel that children should share some of the financial commitment to their college experience. Having some financial “skin in the game” can assist with keeping the students engaged in their academic success. There are two main types of loans: Federal and Private Student Loans. Federal loans are issued by the US Government with a couple of key benefits. First, the interest rate is determined by a formula set forth in federal law and is a fixed rate. Private loans are issued by banks and are similar to other borrowing from banking institutions. Be careful when co-signing loans for a student, you will be responsible for the loan if the child can’t/won’t repay the loans.
Some other strategies for cutting the overall cost of college:
- Some students qualify for college credit while taking advanced placement (AP) classes in high school. This can whittle down the required classes to take once they reach a college campus. It can also boost their standing when enrolling in classes, as some schools look at total hours taken when ranking enrollment priority.
- Consider attending a 2-year junior college before moving on to a four-year school. In California, they have a program where you can gain admission to six UC campuses under the Transfer Admission Guarantee (TAG) Program. This can be a great option for students not yet ready for the four-year institutional experience or those that need an intermediary step but still want to continue their educational path.
- Do research on Scholarships, Grants, and Financial Aid so that you understand where you might pick up some free money for school.
- Apply to multiple schools, let them compete for the student. The Universities want the best students to attend their campus. Many students will not pay the full tuition for a private university. The cost should not limit someone from at least applying if it would be a good match otherwise. If you have a high-achieving student, they could receive grants and aid to certain schools.
- California is a member of the Western Undergraduate Exchange (WUE), which allows a limited number of students to attend undergraduate programs outside of their home state and pay no more than 150% of their home state’s in-state tuition rate.
The Bedell Frazier Financial Planning Department is here to set up your college savings plan. We can run a college savings analysis for you to see if you are on track with your college savings goals and advise on next steps. Please contact us to discuss or if you have any questions, we know how important saving for college is!