A wealth management advisor’s guide to college savings accounts
It’s never too early – or too late – to take every wealth management advisor’s advice and start saving for college. Whether you’re saving for your child, a grandchild, or yourself, you have some options that carry different levels of benefits and risks.
College savings plans are becoming more important as unsecured educational debt levels continue to rise. The Financial Planning Association reported at the end of 2021 that college debt has grown to an unsustainable $1.7 trillion, a sum that surpasses all other types of personal debt. Saving for college is a must, in order to avoid years of payments after graduation.
Here’s a quick run-down of some of the most popular college savings plans and how they might work for you. Not sure how much you’ll need to save for college? Here’s a calculator that can help you plan for one child or multiple children.
Every state and the District of Columbia offer 529 Plans, the most common type of college savings account. But, don’t let the word “savings” fool you – a 529 Plan is an investment account and is therefore not without some risk. Just ask anyone who has one of these plans today (or any wealth management advisor who is currently wringing their hands about client accounts).
529 Plan quick breakdown:
- A 529 Plan is a managed investment portfolio that looks different depending on which state (or private) plan you use. Find out if your state offers tax incentives for 529 Plans using this tool.
- You can choose to invest in any state’s 529 Plan, no matter where you live.
- Contributions to the plan are made with post-tax funds.
- Returns on 529 Plan investments are exempt from Federal taxes.
- Withdrawals used for qualified expenses (tuition and fees, room and board for at least half-time students, books and supplies, and transportation) are tax-free.
- Non-qualified withdrawals are subject to federal income taxes and the potential for a 10% penalty on the portion of funds considered capital gains.
- 529 Plans are typically used for college, but can also be used for private secondary education expenses.
- Qualified Higher Education Expenses (QHEE) are determined by using the school’s Cost of Attendance (COA) and subtracting any grants, scholarships, and tax-free assistance.
- A beneficiary can be changed, so if one child doesn’t use the entire sum, another child, grandchild, niece, or nephew could be named as the new beneficiary.
Pros: A 529 Plan offers tax savings benefits when it’s used for approved educational expenses in the school year in which the expenses were incurred. Add to that the opportunity to build funds through market growth, and it’s usually a sound option for education savings with minimal risk.
Cons: 529 withdrawals can get sticky if you wait to pay December’s spring tuition bill in January, when they’re typically due. Stick to the rules if you’re using funds from a 529 Plan and pay in the calendar (tax) year you make the withdrawal, or you could face hefty taxes and penalties. Make sure you’re using funds for approved expenses, or you’ll face the same fate.
Check out this word of caution from Schwab if you’re investing in a 529 Plan for a grandchild. Ask your wealth management advisor if this is the right move for you.
Unlike a 529 Plan, a Custodial Account is more flexible. Investing in a Custodial Account starts off much like a 529 Plan, but the beneficiary isn’t required to use the funds for qualified educational expenses. There are tax and financial aid eligibility impacts to the beneficiary, so proceed with caution.
Custodial Account quick breakdown:
- Contributions to a Custodial Account are made after taxes, like a 529 Plan.
- Funds are invested with the help of an investment and wealth management advisor, and controlled by the custodian of the account.
- The beneficiary receives control of the account when they reach their state’s legal age (18, 19, or 21).
- Withdrawals must be used for the beneficiary, but otherwise carry no qualifications or tax penalties for the principal amount invested.
- Capital gains on the account are taxed at the beneficiary’s tax rate.
- There are no annual contribution limits or income restrictions associated with a Custodial Account.
Pros: Custodial Accounts can be used by your child for any expenses once they’ve reached the legal age of adulthood.
Cons: Since ownership automatically transfers to the beneficiary when they come of age, the funds in the account become owned assets of that grown child. That could negatively impact their ability to receive financial aid, so speak with your wealth management advisor before setting up this type of account.
Traditional Savings Account
While putting college funds into a bank savings account isn’t going to offer much return on investment, it’s a no-strings strategy some parents and grandparents prefer. Ask your wealth management advisor about better ways to set up high-yield savings accounts to maximize earnings as part of your long-term financial plan.
A retirement account for college savings? It can be done, and some people do it successfully. Using a Roth IRA for educational savings may not be the most advantageous option when it comes to taxes, but it is an investment option that offers more flexibility than a 529 Plan with comparable tax benefits.
Roth IRA quick breakdown:
- Withdrawals from a Roth IRA are tax- and penalty-free for the account holder after the age of 59 ½.
- Before that age, withdrawing what you contributed doesn’t carry a tax or a penalty.
- Returns withdrawn before the IRA matures are counted as income and are subject to taxes, but are exempt from the 10 percent federal income tax penalty.
Pros: Roth IRAs don’t have an education spending requirement, and earnings are free from federal tax penalties if withdrawn before the age of 59 ½.
Cons: They’re not what many wealth management advisors would recommend for maximizing college savings. There are better ways to save, but a Roth IRA could still offer some supplemental education savings if needed.
Talk Over Your Options with a Wealth Management Advisor
Good Life Asset Strategies is here to help you figure out the best college savings plan for your child or grandchild, on your timeline, and within the context of the plan you and your wealth management advisor put into action. Contact us today and let’s find the best college savings solution for you. Remember that it’s never to early to start saving for college!