College Planning and Saving

College Just Ahead Green Road Sign with Dramatic Clouds, Sun Rays and Sky.

June 15, 2016

Planning and Saving for College

Most parents would like to help their children attend the college of their choice. According to a study by Georgetown University’s Center on Education and the Workforce, college graduates can earn up to 84% more over the course of their lives, as compared to high school graduates, so it makes good financial sense to invest in your children’s education.  Many students will be eligible for student loans; however, funding college exclusively with loans can leave your child with a heavy debt burden by graduation.  Students may qualify for scholarships and grants, but generally these sources provide less than half the funds needed to pay for a four-year education.  Having money set aside will provide more options for your child’s higher education.  The question is how to save, and how much.

529 Plans

These plans take their name from the section of Internal Revenue Code that authorizes their use. They are operated by states or by educational institutions, and can be savings plans or prepaid tuition arrangements.  Each state chooses how to structure its 529 plan, and who will manage it.  Earnings accumulate tax-deferred, and withdrawals are not taxed if used for qualified education expenses under current law.  Tax treatment at the state level may vary.  Unlike custodial accounts, the donor retains control of funds.  Balances can be transferred among eligible family members.  Contributions are limited only to the amount necessary to provide for the qualified education expenses of the beneficiary.  Qualified expenses include tuition, fees, books and supplies, plus most room and board expenses.  Distributions used for other purposes are subject to ordinary income tax plus a 10% penalty. Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other benefits that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.

529 Savings Plan: With this type of plan, an investor first chooses from among the different state plans.  There are generally no restrictions as to which state’s plan you can use.  Some states do allow a state tax deduction for contributions to their own state’s plan; however, California does not.  There are many online resources to help you compare plans (web addresses below), and most plans allow for online enrollment.

Prepaid Tuition: Educational institutions can offer prepaid tuition plans, but not savings plans under section 529.  With this type of plan, the investor purchases tuition credits at current prices, shifting the risk of rising tuition costs from the investor to the plan.  These types of plans cover tuition costs only; other arrangements must be made to provide for ancillary costs such as books, supplies room and board.

Coverdell Educational Savings Account or ESA

This type of account offers tax-free growth and a wide array of investment alternatives, similar to an IRA, and can be opened with most investment firms that offer IRA’s. The annual contribution limit is low, only $2,000 per year.  Donors are also subject to income limits:  eligibility to contribute is phased out when Adjusted Gross Income (AGI) reaches $95,000-110,000 for singles and $190,000-220,000 for couples. Threshold figures are for 2016. One advantage of ESA’s is that the definition of qualified educational expenses is not limited to post-secondary schools (college or university) as with a 529 plan. Distributions may also be used to pay for private elementary, middle or high school, or even preschool tuition.

Custodial Accounts/UTMA (Uniform Transfer to Minors Account)

This type of account is established in the child’s name with a parent or other adult acting as custodian. Contributions are an irrevocable gift to the minor child, who gains control of the account upon reaching majority age.  One advantage of this type of account is that contributions aren’t limited to cash, as in the 529 plan and ESA. If you wanted to fund a child’s education using a gift of stock or bonds, this might be the best option.

Tax Incentives

Series EE bonds bought after 1989 are exempt from federal income tax when used for qualified education expenses.  Eligibility is phased out over $116,300 AGI (Adjusted Gross Income) for taxpayers who are married filing jointly.  Lifetime Learning credit eligibility is phased out over $110,000 AGI for married filing jointly, and the American Opportunity Tax Credit is phased out for AGI over $160,000 for married filing jointly.  Threshold figures are for 2016. Eligibility limits are lower for single taxpayers.

Putting it all together: Savings, scholarships, loans and grants

As with any savings plan, your most effective strategy in saving for college will be to start early and contribute regularly. Encourage your children to apply for scholarships, and help them research colleges of interest and financial aid alternatives.  As soon as you know where the child will be attending, have them contact the financial aid office.  Start early!  Most awards are presented around the time of high school graduation, so the deadlines for many scholarships are in the fall of senior year.  The financial aid office can assist the student in identifying sources of aid, including grants, loans and scholarships.  While federal grants are generally need-based, many private scholarships are not.  You may find scholarships available based on a student’s intended field of study or work, clubs and affiliations, the parents’ affiliations, even family ethnicity.  With reasonable grades and willingness to write an essay for the application, students may be able to secure substantial scholarship awards long before the first bills come due.

Internet resources: – learn about 529 plans, tax incentives, financial aid – Department of Education site – the federal site, a great starting point—learn about FAFSA – information on scholarships and other sources of financial aid – College Board financial aid calculator – search for scholarships

Note:  Avoid paying for a scholarship search service!  Many are scams.

The opinions voiced in this material are for general information only, and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing.  This information is not intended to be a substitute for specific individualized tax advice.  We suggest you discuss your specific tax issues with a qualified tax advisor.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Retirement Capital Strategies, Inc. a registered investment advisor and separate entity from LPL Financial.

If you need some help understanding the options in your particular situation, please don’t hesitate to call us at 408-551-6100 or toll free 800-927-8314 and ask to speak with one of our financial advisors or send an email through the contact section of our website.

Best Regards,

Retirement Capital Strategies
A Registered Investment Advisor
1190 Saratoga Ave, Ste. 140
San Jose, CA 95129
Tel (408) 551-6100

Source: This article was written by Margaret (Peggy) Stephan, CFP® – LPL Registered Representative at Retirement Capital Strategies.

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