Best Ways to Save for College
The best time to plan for your child’s college education is before they are born. Think of it as planting a shade tree you want to enjoy 18-20 years from now – you must plant that seedling now to enjoy the shade of the tree later.
Couples can begin this discussion early, from the right time to have children, to the safest car seat, to saving for their child’s education. Discussing your plans and realistic timelines with your financial advisor is a great way to get started. A CERTIFIED FINANCIAL PLANNER™, or CFP®, is a fiduciary who will guide you with your best interests in mind, not their own.
Many of our clients at Heath Wealth Management begin talking to us about college savings plans before their baby is born and put their plans into action once he or she is born. If you waited a few years before seriously thinking about your college savings strategy, don’t worry. The next best time to begin is now!
A Multi-Faceted Approach to College Savings
Parents often think they only need one college savings account per child, and they’re set. We prefer to take a multi-faceted approach that gives the most flexibility, best growth opportunity, tax advantages, and practical options. After all, your current circumstances will continue to change, so your savings plans should be adjusted to meet changing needs. We recommend an annual review with your CFP® to make sure your goals and plans stay aligned.
A multifaceted approach takes advantage of all the tools available:
- 529 plans
- Prepaid tuition plans
- UTMA/UGMA Accounts
- Financial aid/grants
- Student loans
The first three options on this list are contributions you and others can make so the funds grow through dollar-cost averaging and provide tax advantages to parents. A financial planner will help you register funds and schedule contributions for the best benefits. Your strategy should be tailored to meet your family’s goals.
The last three options will help fill any gaps in funds as your child reaches graduation and prepares for college. To create the strongest financial plan for your college savings accounts, it’s important to be aware of these options as they are incredibly beneficial, even if you were able to fully save enough money for your child’s education.
Start with Reasonable Expectations
Consider what your realistic contributions to college savings are and what your future college dreams look like. Your initial monthly contribution amount can be reviewed each year with your planner to determine if you can increase it. Continue that pattern of increasing contributions for as long and as much as is realistic. Also, consider whether grandparents or other family members would like to contribute to your child’s education plan.
Elijah Heath, CFP®, says, “I wholeheartedly believe education for your child’s future is one of the best investments you can make. I encourage my families to review plans on an annual basis to see if there’s a way to do a little bit more. Even $25 a month more, compounded year over year, puts parents that much closer to their college savings goals.”
Once you’ve determined your contribution amount, compare that to the cost of your dream college(s). Remember, no one needs to be a half-million dollars in debt when a child graduates from college. Instead, match your realistic contribution to the right college for your child.
A financial advisor can show you college planning tools online to determine the full cost of college at different schools. Using that information, consider exactly what you want to save for: just 4 years of tuition, include fees and books, dorms and meal plans, or a master’s or doctorate program?
Using the cost tool, parents can decide if they’re able to save for all of these, some of these, or just one of these. Remember to calculate the cost of inflation into college costs which tend to increase 5% – 8%, well above the average inflation rate of 2% – 3%.
In-State vs. Out-Of-State vs. College Majors
Parents should carefully look at the cost of in-state schools versus out-of-state tuition. With in-state schools, parents may be able to save and fully fund four years of tuition instead of only 30%-40% of out-of-state tuition, for example.
As your child gets older, be sure to compare their desired college major with the degrees offered by their favorite college. In some cases, a child may be forced to change their major just to attend a “school of choice” that is not ideal for their major.
Every state has a 529 plan, which is a tax-advantaged way to save money for education. This allows parents to take advantage of saving money while the taxes on growth is deferred. When the money is used later for education, it can be withdrawn tax free. (You can pull money out for emergencies, but there will be penalty fees plus taxes.)
Your financial planner can review your state’s plan and all other state 529 plans to find one with low costs (annual fees plus underlying costs of fund), tax-favorable treatment, and good performance. (For example, if you review a plan with 9% performance but 3% in costs, you are actually receiving 6% growth.)
Some plans have age-based accounts, which means they can be higher risk investments while your child is younger and slowly move to lower risk as your child nears college age. This can be ideal for parents who don’t have the time to closely monitor accounts and choose not to work with a financial advisor.
529 plans have a beneficiary, your child, and no expiration date. This means two things:
- You can change the beneficiary to another child, split it between multiple children, or even move it to grandchildren if the initial child(ren) does not use the money for college.
- Because the 529 plan does not expire, the money can still be available if your adult child(ren) decides to go to college later. Or, perhaps they got a full scholarship for their undergraduate degree and later want to go back for their master’s or doctorate degree.
Another advantage to a 529 plan is that your tax-free earnings can be withdrawn penalty free if your child gets a scholarship. The dollar amount of the scholarship can be withdrawn and used for any other purpose you choose.
529 plans are creditor-protected, so if your family ever faces financial difficulties – a lawsuit or bad credit situation, for example – these plans cannot be touched by creditors.
Grandparents can set up 529 plans for their grandchildren. This is especially helpful later since the assets will not be calculated into financial aid formulas. As part of your overall savings strategy, parents can also encourage family and friends to contribute to the education savings account instead of buying gifts the child doesn’t need.
Elijah Heath, CFP®, shared, “Some of our Heath Wealth Management clients are thrilled to learn they can set up 529 plans for all their grandchildren, which provides both tax advantages to them and the gift of higher education to their grandchildren.
In other cases, we have seen some of our high net worth clients, such as physicians, apply the 529 funds to their own education later in life by taking a cooking class in France or learning to speak Italian while living in Italy. It has to be a real education, and it doesn’t have to be in the US.”
College Prepaid Tuition Plans
Some states offer college prepaid tuition plans, which are a type of 529 plan. One of the benefits of this prepaid plan is that it locks in the cost of in-state college tuition even if future tuition rates are higher than expected. In Florida, the plan offers a set price based on your child’s current age and their projected graduation date. Be aware that room and board costs may not be included unless specifically chosen with your prepaid plan.
Parents can choose an extended payment plan based on their child’s graduation date, a 5-year payment plan, or a lump-sum payment option. College prepaid plans have required contribution amounts, versus the 529 plans which allow parents to put more or less in as their circumstances allow.
UTMA or UTGA Accounts
UTMA or UTGA accounts – Uniform Transfers to Minors Act or Uniform Gift to Minors Act – are a type of savings account with tax advantages but are not specifically designated for college education. Other family members may also make contributions to the account.
Money can be withdrawn by the account custodian (parent) for any purpose that directly benefits the child prior to the age of majority in that state. Once the child reaches that age, the money in the account is turned over to them to use however they choose, even if they choose poorly.
At Heath Wealth Management, we strongly encourage parents to teach their children good financial practices from a young age. This is not only beneficial in general, but also when they are able to access this account. Some good uses for UTMA/UTGA funds during college might be to pay for college-related activities such as fraternity/sorority fees, a college trip/event, or basic needs such as necessary vehicle maintenance. In cases where a child does not need the money for college expenses, they could use it towards the purchase of a home or new vehicle, for example.
Speak with your CERTIFIED FINANCIAL PLANNER™ about the tax advantages of all funds in the child’s name since 20% of the account balance can be counted towards the family’s Expected Family Contribution (EFC) when applying for financial aid.
Financial Aid and Grants
Many parents make the mistake of not filling out their FAFSA forms (Free Application for Federal Student Aid) to see if they qualify for financial aid. This is a good source of additional funds and should not be overlooked. Even if you think your family income is too high, or you feel embarrassed your college savings plans weren’t adequate, fill out the FAFSA! Any amount of aid is helpful towards college expenses.
The FAFSA uses a formula to determine your family’s Expected Family Contribution (EFC) amount when applying for aid. Your financial planner will guide you on how you hold money and how it is registered, which plays a big role in the financial aid process. Having funds set up properly not only gives parents the best tax advantages along the way, but it also creates the best growth strategies so your plans are financially sound year after year.
Grants are another important option, and some don’t have to be paid back. Every year, hundreds of millions of dollars in grant money are not awarded to students because people are not aware of them. With a little patience and searching, your child may be able to receive multiple sources of aid through such grant programs. (Beware of scams that want to charge money to show you scholarships and grants. This information can be found for free.)
All scholarships, whether athletic, needs-based, merit-based, or ROTC, have specific requirements to keep the scholarship. While your child may have balanced school and other activities well in high school, college could prove to be more challenging than expected. Be sure you and your child have a clear understanding of all the requirements to retain their scholarship and have a plan to fund their education if they lose it (approximately 40% – 50% lose their scholarships).
Additionally, carefully consider scholarships that offer a high dollar amount for an expensive school, but still leave you responsible for a higher tuition payment than you planned. For example, a school might offer a $50,000 scholarship, but you are still responsible for $30,000 a year in tuition and other expenses. In some cases, you may need to say no to such offers.
Lean on your financial planner to help assess and decide on such offers so you can make the best financial decision.
Bank of Mom and Dad
One potential financial option can be the “Bank of Mom and Dad”. Even if parents have saved and planned for college expenses, there will be unexpected ones that occur (extra classes, replace a computer, or vehicle repairs). Parents need to be aware of, and plan for, this.
In many cases, parents may decide to pull money from their retirement accounts to help their child. CFP® Elijah Heath strongly discourages parents from doing this because they have a limited number of years to repay the money they borrow in addition to making additional contributions to catch up.
Heath says, “If your retirement account is your only other source of savings, look at getting a student loan instead to help your child. You can get a loan to help pay for college, but not for your retirement.”
Even after you have saved, applied for financial aid and grants, or received a scholarship, there may still be a gap in what is needed to fully pay for college. Parents should consider a student loan at this point to help with those costs. There are subsidized and unsubsidized loans your student can take out, and parents can decide to help their child pay some of that back.
Remember, your child has many earning years ahead of them and parents need to remain focused on their own retirement savings if their budget only allows for one financial commitment or the other. Find a balance between sending a child to college and saving for your own retirement.
Planning and Saving with a CERTIFIED FINANCIAL PLANNER™
Finding the right financial planner to set up college savings plans for your child is the best choice for every family. Their fiduciary responsibility ensures they have only your financial goals in mind when making recommendations on your college savings plans. At Health Wealth Management, we strongly encourage families to use our multi-faceted approach that includes multiple savings options and enlisting the help of family to contribute when it makes sense.
If you would like to discuss the best ways to save for your child’s college and review options that make sense for your exact circumstances, please call Elijah Heath, CFP®, today at 813-556-7171 or email him at Elijah.Heath@LPL.com.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
Tax treatment at the state level may vary. Please consult with your tax advisor before investing.