According to EducationData.org, the average annual cost of a 4-year in-state public college education is $21,950, which includes $10,440 for tuition and fees and $11,510 for room and board. Depending on a family’s financial situation and the city the college is in, this could be lower or much higher, but that’s a fair average for what I’ve seen over the years. When a child is born, you’ve got 18 years to make sure you have the eighty thousand plus dollars ready to go to cover those costs, otherwise you’ll be using your family cashflow and/or student loans.
Where to save those dollars might be just as daunting of a task as there are many options available and many opinions offered throughout the financial advisor community. Generally, the first thing to consider is funding a 529 account. Every state offers a 529 plan and most states offer a state income tax deduction for the contributions, or a portion of the contributions made to the plan. You are not required to use your state’s plan, but it usually makes sense if the deduction is available. When you make a contribution to a 529 account, the funds are invested, and they grow tax deferred. When you get to the point of using these dollars, the investment gains are not taxable as long as you use them on qualified higher education costs (tuition/fees, room/board, books, computers, etc.). It’s rare that the IRS offers tax-free gains, so this is a great opportunity for investing and growing money for college.
The main problem with the 529 plan however, is the lack of flexibility. What happens if your child gets a scholarship, or decides not to go to college? What about when they move off campus as upper-classmen and the expenses are harder to provide receipts for? If 529 dollars are pulled out of the account and not used for qualified higher education expenses, you pay income tax and a 10% penalty on the gains portion of the distribution. Because of this potential risk, we generally have families fund a 529 plan up to 50% of the funding need then we evaluate the college outlook of each child in the family. Depending on the situation, we may take the 529 funding up to 75% of the need. Whenever we stop the 529 funding, we will open a taxable brokerage account owned by the parent to continue funding until 100% of the need is met. There are no restrictions around the use of the brokerage money so it’s much easier to navigate those final years of college and we’re willing to give up the tax advantages for the flexibility.
Another benefit to the 529 plan is you can change the beneficiary on the account so if one child decides not to go to college, you can give their account to another child, or even to the parents if they are pursuing additional education.
There are other options for funding college educations that are often recommended by financial advisors – ROTH IRAs, Coverdale College Savings Accounts and Whole Life insurance. ROTH IRAs and Coverdale IRAs are viable options, but both have annual contribution limitations that make it hard to save what’s needed, and the ROTH IRA has income limitations which eliminate most of our clients from being able to contribute. Another common recommendation we see is to fund a whole life insurance policy and then take policy loans from the cash value to cover college costs. While this can work, we see it as an expensive way to save for college as you’re paying the cost of insurance, contract fees, commissions, etc. which really add up over time.
Today we addressed a specific topic, but college education planning should not be done in a vacuum but should be a part of a holistic financial plan covering all aspects of your wealth as there may be other, more creative ways to handle college costs. But for most, the 529 is a great place to start and the Personal CFOs at Crown Wealth Group are skilled at incorporating this important goal into your overall plan.