Where Should I be Saving for College?
Whether you have dreams of sending your newborn child to Harvard, UC Berkeley or San Diego State, you have a lot of savings ahead of you if you plan to foot part of the bill.
You need to come up with a savings plan EARLY – and stick with it for many, many years.
Various types of savings plans exist. In fact there are a few specific ones that are commonly adopted by parents to save for college. Those include:
- Traditional investment savings accounts.
- UGMA (uniform guest to a minor’s accounts in their name).
- UTMA (uniform transfer to a minor’s account in their name).
- 529 College Savings Plan.
- Coverdell Education IRAs
- US Savings Bonds.
But before deciding where to save, the first question most parents ask is “How much do I need to save?”
As an example, let’s calculate how much you need to save for your newborn to afford 4 years at a UC. Today, a UC will run you about $32,000 per year or $130,000 for four years. Tuition cost as well as room and board continually rises about 4-8% per year. If we assume a 5% inflation, these parents will be faced with a $300,000 to $350,000 college bill when their child reaches 18 years old.
These parents of a newborn would want to stash away $1,000 per month, equaling $12,000 a year (assuming an average 4.5% rate of return over 18 years) to accumulate ~$320,000 to fund that one child’s college education. Wow – that’s a lot of savings and may be overwhelming for many new parents to consider!
So now that we know how much we need to save, the next question is how and where should these funds be saved for the next 18 years?
There are 4 key components that should be considered in the decision of where to save these college funds. Those 4 factors are the savings plan, the investment strategy, having access to your money and the spending plan.
- Savings Plan
- Should be easy – auto withdrawal.
- Contribution limits.
- Outside help – choose a convenient way for family to help.
- Investment strategy
- Choose your risk and expected return.
- How will taxation impact our rate of return (tax now, tax every year, tax later)?
- Access to the money
- Would you like access to this money during the saving period?
- Access if you have an emergency.
- Access for a great investment opportunity.
- Spending Plan
- Flexibility. Timing.
- Do you want to have all your money in a plan that must be used for college funding?
When it comes to college savings and funding, a vital 5th component may be whether the savings are visible or invisible to the financial aid calculation. Every family should assess whether it is possible that they may qualify for need based financial aid, and if they do, then the 5th component becomes all-important.
Listen to the April 19th College Smart Radio show to start to run the numbers of how much to save and why these 4 or 5 components should be serious considerations for your savings plan. Listen in to next week’s show to understand the pros and cons of different savings plans, so you can determine which single plan or combination of plans is right for your family.
529 Plan, Stocks , Mutual Funds, UTMA, UGMA, Coverdell, Roth IRA, Cash Value Life Insurance… How do you decide which savings plan or combination of plans are right for you?
There are many components that should be considered in the decision of where to save your valuable college funds. In “Where to Save For College? Part 1”, we discussed how to calculate how much you’ll need to save and the basic (yet key) factors to keep in mind when taking into account different college savings plans.
Most commonly, I hear parents worried about taxation when deciding on their specific savings strategy. Taxation can be a big deal in a good way and a bad way. As an example, 529 Plans have the tax advantage that earnings are not taxed if the money is withdrawn for a qualified education expense. That’s the good taxation. The bad taxation arises if you need some of that money for a non-qualified education expense or if your student decides that higher education is not for them. In either case, you’d have to pay the tax plus a 10% penalty to get access to the money.
Another frequently discussed feature is whether the college money should be in the parent’s name or the child’s name (UGMA or UTMA). The tax decision will depend on the child versus parent’s tax rate, when the money will be accessed and the kiddie tax rules. The other central feature that parents sometimes forget is access to that money. It is essentially the child’s asset and they gain control of it at age 18.
The Roth IRA’s taxation rules allow money to be taxed when earned, but not taxed during accumulation or withdrawal (subject to some limitations). Roth IRA limits contributions and these limits are dictated by family earned income as well as IRS rules (only $5000 per year for an adult under 50).
One lesser known savings vehicle is to save money is cash value in a permanent life insurance policy. Savings will accumulate tax deferred and, if the policy is designed correctly, are available to being spent… tax-free! Contributions can be high and money from the cash value in the policy can be accessed for any need (not only college).
When it comes to college savings and funding, a chief element for many familiesmay be whether the savings are visible or invisible to the financial aid calculation. Every family should assess whether it’s possible that they may qualify for need based financial aid, and if they do, then the financial aid visibility becomes all-important.
To give you a clear visual, the chart below compares different savings plans and the possible benefits of each.
|Guaranteed Growth||Tax Deferred Accumulation||Tax Free Use for College||High Contribution Limits||Investment Choices||Transferable (beneficiary)||No Income Ceiling for Contribution||Access to Money||Financial Aid Invisible|
|529 Plans||NO||YES||YES||YES||Some Limitations||YES||YES||NO||NO|
|UTMA / UGMA||NO||NO||NO||YES||YES||NO||YES||NO||NO|
|Stock / Mutual Funds||NO||NO||NO||YES||YES||YES||YES||YES||NO|
|ROTH IRA||NO||YES||YES||NO||YES||YES||NO||Some Limitations||YES|
|Permanent Life Insurance||YES||YES||YES||YES||Some Limitations||YES||YES||YES||YES|
When we work with a family to design their college savings plan, it typically will include a combination of these different plans. This allows a family to take advantage of the benefits of each, but lessen the disadvantages. Give us a call to help design your unique college savings plan.
Listen to the April 26th College Smart Radio show to understand the pros and cons of different savings plans, so you can determine which savings plan or combination of savings plans will integrate best with your family’s needs.
This post highlights information discussed during our College Smart Radio “Tackling the Runaway Cost of College” April 26th broadcast where Beatrice Schultz and Mark Guthrie discussed the pros and cons of different college savings plans. Listen to this broadcast on YouTube here.
Tax advice is not offered by Beatrice Schultz or Westface College Planning. Please consult your tax professional for additional guidance regarding tax related matters.
Photo Credit: Images of Money
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