From the Desk of Charlie McCullough
As a parent of a college student, I am in the throes of financial aid information. On January 1, we filed our information with FAFSA, just like we were told, and now we wait, to find out about the little gift the federal government has in store for our student this year. While many parents do not have the benefit of a do-over when they reach the point of sending their children to college, I am fortunate in that I have time to create an appropriate savings plan for my youngest child Ava, who will be starting Kindergarten in the fall.
To be fair, the gift of time does not make deciding what college savings tool to utilize any easier this time than it did when my older children were small. This is why I am so glad that I have the insight of the team at Financial Fiduciaries to guide me in these difficult decisions. So, with that in mind, here is what I can tell you about college savings tools. But, before we discuss the plans, it is important to lay the groundwork for your decision. Consider these questions before you make your final decisions:
- What type of college does your child plan on attending? Private? Public?
- How much money will be invested annually?
- What type of financial aid will you be applying for?
- Who should be in control of when money is withdrawn from the plan?
- Do you want control over where the money is invested?
A 529 plan is the most common way to create a college savings program for your child. The money that is invested in the plan is free from Federal tax and in many states, it is also free from state taxes. The money can be used at any time, as long as it is used to pay for school related items. The individual who opens the account is also in control of when and how the money can be utilized. In general, there are three types of 529 plans: Pre-paid tuition plans, savings plans and independent plans.
- Pre-paid Tuition Plan – A pre-paid tuition plan allows you to lock into the current tuition pricing for a specific public school within your state of residence. There are several types of prepaid tuition programs. In most cases, participants are allowed to pay for their children’s college tuition from the day they are born until the day they enroll in college. By locking in the tuition cost, you won’t need to be concerned with rising costs in years to come. It is important to know that each state has their own pre-paid plan and that the plan does not guarantee admission to the school of choice. Also, if your child chooses not to go to school you will receive the original contribution with a reduction or elimination of compounded interest. This plan could also reduce eligibility for financial aid.
- College Savings Plan – With a college savings plan, your contributions are invested in mutual funds or similar investments. The value of the plan fluctuates based on the performance of your funds. The money can be used for tuition, room and board, textbooks and supplies at any qualified college. Small deposits are accepted (often as little as $25 per month) and funds can be used at any accredited U.S. college or university. This plan generally offers a higher return on investment than a pre-paid tuition program
- Independent Plan – Like the pre-paid tuition plan, an independent plan is designed and run by a consortium of 270+ private participating colleges. The plan allows families to lock into a discounted tuition in return for participating in the college in the future. If the child chooses to attend a school other than one in the consortium, you can roll the plan over to a tradition 529 plan, however, earnings are capped at 2% per year. Unlike the other plans, this plan does not cover board and other expenses. It only applies towards tuition and mandatory fees.
The Uniform Transfer to Minors Act (UTMA) allows the creation of a savings account for a minor that does not include spending restrictions. It is a revised version of the Uniform Gift to Minors Act (UGMA) and is available in all states except South Carolina and Virginia (they still have the UGMA) for the creation of a savings account for minors, one without spending restrictions.
An UTMA account allows gifts to be passed to a minor. The minor is able to take control of the account at an age determined by the state (18 to 21 years). The account is overseen by a custodian until the child is able to legally take control of the funds. The account does have spending restrictions until the child is able to take over the account.
Money earned in the UTMA account is taxable, however the first $950 earned each year is not taxable for minors under the age of 18. Additional income may be taxed at lower rates depending upon the state. Additionally, because the account is technically owned by the child, it can have an impact on financial aid assistance received.
Coverdell Education Savings Account
A Coverdell Education Savings Account allows contributors to save and invest money for college expenses, tax-free. The account allows for a maximum contribution of $2,000 per year, per child. Additional deposits are subject to a 6% annual penalty fee. The account must be created and all contributions made before the beneficiary reaches the age of 18. The beneficiary must take advantage of the account before the age of 30.
With so many investment options to consider I am glad for two things: 1. We are starting early in our college savings plans for Ava; 2. I have the benefit of receiving advice I can trust from my advisor. Sending a child to college is complicated enough, choosing an investment tool to get them there should not be.