According to higher education reports, tuition and mandatory fees consistently rise every year, but state spending for higher education in numerous ways is decreasing. Along with rising costs associated with higher education, there is an even greater danger after an individual graduates. The average graduate of 2014 is leaving school with an average of $33,000 in debt. The total student loan debt is over 1.2 trillion and climbing. According to Forbes.com, of this $1.2 trillion in student debt, about $1 trillion is in federal student loans. This figure does not tell the full story, however, as the $1.2 trillion does not include funds students must divert away from retirement savings, parent borrowing, or credit card debt. Unlike any other kind of debt, student loan lenders are continuing to provide loans to borrowers so young to where they do not have a proven financial track record or a substantial credit history. Likewise, after one graduates it has become more challenging than ever to find a stable job immediately.Therefore, go ahead and throw in the recent increases in federal student loan rates, and you see a trend where family support or loan consolidation efforts are often the norm long after the degree is earned. This phenomenon has greatly affected the financial situation of those in their 20’s by stunting long term savings, investing, delaying home purchases and often their independence as young adults. According to the College Board, the average cost of tuition and fees for the 2014–2015 school year was $31,231 at private colleges, $9,139 for state residents at public colleges, and $22,958 for out-of-state residents attending public universities.Therefore, If higher education is part of our children’s future, then being educated and funding it without significant amounts of scholarship money has to be planned for, and the earlier the better. But then what? Is it possible to make that investment continue to perform for them beyond the years in the dorm?
Questions arise such as, “How much are we going to pay for it and how much is our children’s responsibility?” ; “Public education or Private?” ;“What if they want to major in ____? Will the degree be worth the cost?”
In a perpetual manner, these questions always end up funneling back to the original, “How are we going to pay for college?”. And regardless of your family’s answers to any of these questions, the numbers involved in higher education are staggering.Therefore, in today’s economy one must objectively look at all angles, analyze one’s own financial portfolio, time, and utilize efficient strategies for planning with higher education. Currently, there are several options for investing or savings for higher education. We plan to lead and educate you on what is out there. Factoring in Opportunity costs, Safety of earnings, tax treatment of the plan, and inflation is absolutely essential with any higher education funding.
529 Plans: 529 plans are administered by state agencies and organizations and named after section 529 of the Internal Revenue Code 26 (USC). 529 plans are tax-advantaged savings plan designed to encourage saving for future college costs. 529s benefit from federal tax and some state tax advantages. Every State now has at-least one 529 plan available. It is up to each state to decide whether it will sponsor a 529 plan (or possibly more than one), and what the plan will offer. Assets may be used for eligible college expenses: tuition, fees, room board, textbooks, school supplies and a computer (if required by the institute). Any U.S. taxpayer can open a 529 plan for ANYONE – including, yourself!Account owners do not need to live in the state sponsoring their 529 plans, since most do not have state residency requirements. Accounts can be opened in as many states desired AND the beneficiary can go to any accredited institute in the U.S. or abroad.
501c3 Non Profits can open 529 plans just like an individual for ex: A scholarship.Family and friends can contribute to an existing 529-college savings account. Our 529 plans make it simple to Make a Gift. If the child does not go to college you can change the beneficiary penalty free. To avoid taxes and penalties, your new beneficiary must be a member of the family of your original beneficiary. Certain restrictions apply. Please consult your tax advisor and the Plan Disclosure for more detailed information regarding a change in beneficiary.
Types of 529 Plans:
- Direct Sold Savings Program: These plans are typically set up and managed by each state, and in doing so, the fees involved can be significantly less than programs set up by investment firms. This doesn’t mean that no fees are involved, just less fees. One study showed the state fees ranging from $51 to $2,488 over a 10 year period. Many of these state run plans offer state income tax breaks for contributors that are also state residents. Inside the plan, it works much like a 401k or IRA by investing your contributions in mutual funds or similar investments. These usually offer you the ability to manage your investment portfolio or use a predetermined age-based mix of investments. The particular investment products can have fees tied to them as well so be aware. Also note, you can only make portfolio adjustments once a year, making responses to market changes in a timely manner very difficult.
- Broker Sold Savings Program: These come with an advisor to help manage, however this also means you pay sales charges or incur other fees to compensate the advisor, and the plan will work much like a 401k or IRA by investing your contributions in mutual funds or similar investments. These fees on the Broker Sold Programs can be highly variable. Many of the large investment firms offer no annual fees, instead the fees come directly from the assets you choose to invest in, so do your homework on expenses of each particular plan, as expenses can drastically compromise your income growth. Generally speaking, the Broker Sold Programs carry higher costs and don’t give you the state income tax breaks that some state held direct savings plans offer. For the higher fees and lack of income tax deductions you typically get many more investment options, so the gamble is that your investments will outperform investments in a direct sold program and overcome the increased expenses. Once again, note that you can only make portfolio adjustments one time per year, limiting your ability to respond to market changes.
- Prepaid Contract: These allow you to purchase a contract covering 1 to 5 years of tuition either on a lump sum or installment basis. Prepaid plans allow you to pre-pay all or part of the costs on an in-state public college education at today’s rates, freezing the tuition costs at current rates. They may also be converted for use at a private and out-of-state colleges. Depending on the plan, you may or may not get the full value of your plan if used on private or out-of-state tuition.
- Prepaid Unit/Guaranteed Savings: These allow you to buy ‘units’ of tuition which may equate to credits or hours. Prepaid plans allow you to pre-pay all or part of the costs on an in-state public college education, freezing the tuition costs at current rates. They may also be converted for use at a private and out-of-state colleges. Depending on the plan, you may or may not get the full value of your plan if used on private or out-of-state tuition.
A second, but less popular plan is the Coverdell Education Savings Account. Its tax benefits were made permanent with the American Taxpayer Relief Act of 2012 (ATRA) – although has been around since 1998 when it was called the Education IRA, and can be set up through a majority of the investment firms. Its only advantage to a 529 Plan is that it considers expenses for primary, secondary, and post-secondary education expenses, including tuition, fees, tutoring, books, supplies, related equipment, room and board, uniforms, transportation and computers as qualified expenses. Therefore, you CAN use this for private primary or secondary expenses, which a 529 Plan cannot. Besides that, the Coverdell is a quirky savings plan with a lot of rules and limits. ESA Plans include:
- Single: Adjusted Gross Income of $95,000-$110,000 (income between $95,000 and $110,000 will have a reduced allowed contribution).
- Married Filing Jointly: Adjusted Gross Income of $190,000 to $220,000 (income between $190,000 and $220,000 will have a reduced allowed contribution). Although some have suggested that if your adjusted gross income is too high, you can consider gifting the Coverdell money to your child and have them contribute to the plan. Consult your CPA if you’re considering this.
- There are also contribution limits on each beneficiary of $2,000 per year for that child until age 18, at which point you can no longer contribute. This limit applies to relatives as well, as they cannot open a separate account with the child’s name and add an additional $2000. The cumulative amount contributed for any beneficiary must not exceed $2000 per year no matter how many accounts are set up. Contributing more will exceed the contribution limit and will cause your child to owe 6% excise tax on the excess funds.Inside of these accounts, the assets purchased (such as mutual funds) may have fees themselves, further compromising growth. Fees within these savings accounts are determined by the investment firm setting it up and the particular investment inside the account, however, if you do some searching, there are many options out there with $0 annual management fees. Do keep in mind however, that with a maximum $2000/yr donation, even a $20/yr fee equates to a 1% expense ratio.
Unlike some 529 Plans, Coverdell ESA’s do not offer any state income tax deductions. The earnings accumulate tax free and distributions are federal income tax exempt if the expenses are considered qualified. Unspent funds must be distributed at the age of 30, subject to income tax and a 10% penalty on account growth if beneficiary does not have qualified education expenses that year. So make sure you go back to get that MBA before you’re 30. Fortunately, if set up correctly, you can convert a Coverdell ESA to a second beneficiary as long as the beneficiary is under the age of 30 and a member of the original beneficiary’s family. You also have the option to convert a Coverdell to a 529 Plan, but not the other way around.It is important to note that funds distributed from a 529 Plan cannot be claimed for the Standard Tuition and Fees Deduction or programs like the American Opportunity Credit.Regarding the ownership of the account, Coverdell ESA assets are not revocable, the account must be established for the sole benefit of the child. The bank or financial institution is the custodian (much like and IRA), not you. Also, while the defined ‘responsible individual’ on the account decides the investments and the distributions, the distributions cannot come back to them, only the beneficiary.
A Coverdell ESA is treated as an asset of the account owner – which can have a high impact on financial aid eligibility if the account is owned by the student. (Note that the Higher Education Reconciliation Act of 2005 added special treatment for Coverdell, Prepaid Tuition, and 529 College Savings Plan accounts owned by a dependent student. The impact on need-based aid for dependent students will therefore be minimal.) 5.6% of the value of your Coverdell ESA at the time of your FAFSA application will be calculated into your child’s Expected Family Contribution (EFC), compared to 20% for custodial accounts and your beneficiary’s assets.