10 Questions About Saving for College
Saving for college can be stressful. How do you evaluate all of your options and make the right decision? How much do you save and which type of account should you use? This is a common challenge for families. In an effort to shed some light on the subject, below I’ve answered the 10 most common questions I get asked about saving for college.
1. How much should I save each month towards college expenses?
This is a great question. There are a lot of good calculators out there to get you started. I'm located in Virginia and often recommend the Virginia 529 to clients. Their website offers calculators to help you determine the cost of college and how much will need to be saved.
What these calculators won't help you do is see how saving for college fits into your overall financial picture. I suggest thinking about the following questions, first:
How much can you afford to save?
How many years away are your kids from college?
Are you considering public or private schools? In-state or out-of-state?
Do you think you will be eligible for financial aid?
How many years of school are you intending to fund for your child? Two? Four? Grad School?
Will there be other sources of funds (i.e.: contributions from grandparents or another family member)?
What are the other goals you are saving towards? Cash reserve? Retirement? A home purchase?
How do you rate saving for college as a priority as compared to your other goals?
2. How do you balance saving for college with saving for retirement, as well as other financial obligations?
It's a balancing act. The answer is different for everyone. In general, you wouldn't want to put yourself in debt or skip retirement savings in order to save for college. You can't forget saving for retirement is important too, arguably more important as there is no financial aid or loans for your own retirement. If you do some work to prioritize your goals, it will be much easier to determine where to place saving for college on the list. If you are struggling with prioritizing, I recommend working with a financial planner to help you clarify.
3. What are the benefits of a 529 account?
You often hear 529s are a great way to save for college, but why is that? It’s simple, tax-free growth and tax-free withdrawals if you play by the rules. This makes 529s stand out from most other types of investment accounts. The dollars you contribute are invested and grow tax-free. The withdrawals are also tax-free if they meet the requirements for qualified education expenses. These are things like tuition, books, fees, room, and board. In 2019 the IRS allows you to contribute up to $15,000 into a 529. There is also a lesser known 5-Year election in which you can contribute up to $75,000( 5 years x $15,000) into a 529 account at one time.
4. And the catch is…?
The caveat is the IRS requires 529 funds to be used for qualified education expenses (tuition, books, fees, room, and board). If 529 funds are used for something else, the funds are taxable when withdrawn and are also subject to an additional 10% penalty. If you questioning whether or not a particular expense is qualified, I recommend contacting your tax advisor for more information.
5. What should I consider when selecting a 529 account?
There are a number of things to think about. Here are a few:
Where will your child attend school? In-state, out-of-state, public or private?
Will you select the prepaid or savings option?
What are the investment options the plan offers?
What are the plan fees? What are the internal fees for the investments?
Will you open the plan in your state? Or do you prefer another state's plan?
Is there a tax deduction in your state for contributions to a 529?
6. What is the difference between a pre-paid plan and a savings plan?
A prepaid plan allows you to purchase a semester today to be used when your child attends a state college in the future. The prepaid plan covers the cost of in-state tuition only, so other arrangements will need to be made for room and board and other expenses. Think of it as a credit system, today you purchase 4 semesters at a state school and when your child attends a state school in the future, you’ve got 2 years of tuition covered. If your child attends a state school, you’ve made a great investment by paying for a semester in today’s dollars. If they go out of state or attend a private school, it's not such a good deal. You may only be entitled to your contributions plus minimal interest. In other words, not the number of semesters you purchased on the prepaid plan.
The savings plan allows for more flexibility. If you don’t know if your child will attend an in-state school or a public school, this is most likely the best option for you. Essentially, you are saving into an investment account and letting it grow. Funds can be used for any qualified education expense, unlike the prepaid option which limits you to tuition only. If your child attends a public or private school located in-state or out-of-state, the dollars are accessible to use and there are no limitations outside of the normal IRS limitations for qualified expenses.
7. What if I expect to move to another state? Should that affect my choice of what 529 plan I open?
You are not restricted to 529 plans within your state. For example, a Virginia resident could open a Nevada 529 if they liked the Nevada Plan options better. You also have the option of rolling over your 529 plan into another state's plan. Just because you move doesn't mean you have to change your 529. This, however, will most likely impact any state tax deductions if applicable so consult your tax advisor. Where this becomes important and there could be downfalls is when a prepaid plan is selected. If you move to a different state and your child attends college in this new state you may only be entitled to your contributions plus minimal interest and not the number of semesters you purchased on the prepaid plan.
8. What if my child gets a scholarship and doesn’t need the funds?
There are several options:
The 529 could be used for another child. Funds can easily be transferred to another beneficiary. When transferring outside of siblings (or the same generation) be sure to involve your tax advisor to understand if there are gifting implications.
If that is not an option, you can still enjoy some of the tax benefits. For children that receive a scholarship, the 10% withdrawal penalty is waived if withdrawn for reasons other than qualified expenses. In other words, only earnings will be taxable as income.
Funds can be used for Grad school.
9. My parents want to help contribute to a 529, is it better for them to open their own account or contribute to our 529 account?
So, I always tell clients this depends on what the parent or grandparent is trying to accomplish. There is the right tax answer, financial aid answer, and then there is the right answer for the family dynamic. The three of these don't always align. Here are some things to consider:
Sometimes, grandparents prefer to have more control and don't want to hand over ownership of the account to their child. In this case, the grandparent should be the owner. It's their money and therefore their choice.
If control and oversight of the funds is not an issue, grandparents can contribute directly to the parent owned 529.
There’s lots of talk about grandparent-owned 529s and their impact on financial aid eligibility. It’s true, they are viewed differently on the FAFSA. Distributions count as income to the beneficiary in the year taken, which lowers eligibility, so timing is important. For example, if grandparent funds are used senior year there are no more FAFSAs to file and therefore these income distributions won’t need to be listed and won't impact aid.
Who wants the tax deduction (parent or grandparent), if it's offered in the state? Remember it needs to be a Virginia (or name a state) owned 529 in order to qualify for the state specific tax deduction. Again consult your tax advisor here for more details on eligibility.
10. What are my other options(besides a 529) when saving for or paying for college?
Many families pay for the cost of college with a combination of income and savings. In addition to 529s, other accounts can also be utilized to save for college. Regular savings accounts can be used. Traditional and Roth IRAs can also be used. There are a lot of different options all with pros and cons and different tax implications. Saving into other types of accounts that are not just designated for education may provide you with more flexibility. It's best to consult your financial planner to determine what other options would be most appropriate for your family.
If you are interested in learning more about 529 plans. I recommend checking out the following resources:
Read more about my firm, and check out my service options.
Christine Centeno, CFPⓇ, MS is the founder of Simplicity Wealth Management. She has over 11 years of industry experience as a financial advisor and is a member of several professional organizations including NAPFA, FPA, and the XY Planning Network. In 2018 she completed her Masters in Financial Planning. In 2019, after years of working for large firms, she founded her own firm. Simplicity Wealth Management provides clarity to the complicated nature of financial planning and investing by delivering comprehensive advice without hidden fees and unnecessary jargon that leaves you in the dark. The goal is to deliver transparent, easy-to-understand guidance to help clients achieve their financial goals and remain informed every step of the way.
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