529 Plans
529 plans offer tax-free investing and tax-free distribution for college education expenses with minimal impact to financial aid eligibility. Every state offers a 529 plan (generally two plans, broker sold and direct) and 34 states offer residents tax benefits for investing in their state’s plan. An individual can contribute up to $14,000 a year ($28,000 per couple) or front load up to 5 years at one time ($70,000 or $140,000 per couple). To keep fees low, we would suggest adopting an index age-based allocation within a direct plan, which avoids any broker/advisor fees and automatically shifts the portfolio allocation to become more conservative as the child approaches college.
Coverdell Education Savings
Coverdell education savings provides tax-free investing and withdrawals for any level of education (including high school, etc). There is a maximum $2,000 annual contribution for a beneficiary. For wealthy families, contributors are subject to income limitations. Also noteworthy is that all funds must be disbursed to the beneficiary before he or she turns 30, which may be an issue if the child decides to take time off from college or use the funds for graduate work.
Custodial Account (UGMA/UTMA)
A custodial account offers the most flexibility as these accounts are intended to be used for the child’s benefit, which may not necessarily mean college. Control is an issue that arises for parents as the child assumes full direction of the account at the age of majority (usually 18 or 21). We generally recommend alternate vehicles for college funding since UGMA/UTMA’s have a high impact on financial aid eligibility and earnings tax to the child or parent (ie. kiddie tax).
Prepaid Tuition Plans
Many states offer prepaid tuition plans to lock in the cost of tuition at any given year. These plans have grown in popularity as prepaid tuition plans are not subject to market volatility. With college expenses rising 11-14% over the past 5 years, locking in guaranteed tuition rates alongside the use of a 529 plan for personal expenses can be a good combinationiii. A meaningful downside for prepaid tuition plans is that choices are limited to in-state school programs so any student who opts for out-of-state or private schooling is generally offered a reduced conversion rate to transfer their purchased credits.
Retirement Savings
Nearly one in three parents either plan to use or would consider depleting retirement accounts to fulfill college needs. While it may be a quick plug for funding gaps and disbursements can be exempt from the 10% early withdrawal penalty, it is important to note that Traditional IRAs are taxed as federal ordinary income rates (up to 39.6%) and withdrawals have a significant impact on financial aid packages as 50% of disbursements are treated as student income.
Scholarships
While only 0.3% of college students receive enough grants and scholarships for a full ride, 46% of students received some sort of merit-based scholarship averaging $8,843 in 2015iv,v. Applying for scholarships can be a great way for students to contribute to their education.
For assistance with evaluating college savings vehicles, please contact any of the professionals within The Wealth Office™ at DiMeo Schneider & Associates, L.L.C.
