Sign up to receive
our E-newsletter

Is an Education Really Priceless?

By Nicolas Valdes-Fauli, CFP®

It’s common knowledge that the costs to educate a child in this country are becoming prohibitively expensive. It is also common knowledge that children need a good education to succeed in life. So unless you are really wealthy, have a Rockefeller as a godparent or have a pretty amazing cash flow, what is a couple with children supposed to do? Our solution is save over time with a plan to meet your future educational expenses (but NOT forgetting to save for your retirement).

Higher education costs are high now and they are not getting any cheaper. Actually, over the decade 2000-2001 to 2009-2010 published tuition and fees at public four year colleges and universities increased at an average rate of 5.6% ABOVE the average rate of inflation, conservatively estimating the annual increase to be about 7.5%*[From the College Board Policy and Advocacy Center Trends in College Pricing 2010] (no, that is NOT a misprint). And with states facing higher and higher budget deficits, state schools, once a bargain, will only get more and more expensive.

Let’s assume you have a newborn child or grandchild. Here is what the numbers currently look like and what they eventually might look like:

Tuition, Fees, Room and Board:

Public:

Public Four Year Annual Cost 2011 (one year): $16,140

Public Four Year Annual cost in 2029 (one year): $59,327

Lump sum needed (2011) to fund four years in 2029 assuming 5% growth: $98,603

Private:

Private Four Year Annual Cost 2011 (one year): $36,993

Private Four Year Annual Cost in 2029 (one year): $135,975

Lump sum needed (2011) to fund four years in 2029 assuming 5% growth: $226,007

These numbers look scary and I am NOT even a parent yet . . .

What can you do about this? Start saving!

We generally recommend a 529 plan to be the best vehicle to plan for a future educational expense. Other options for college funding are UGMA/UTMA custodial accounts and 2503(c) trusts, but the 529 trumps them all.

529 plans, officially called “qualified tuition programs” have benefits that other options simply do NOT offer. The biggest advantage is that contributions to a 529 grow tax deferred and all earnings are TAX FREE if used for qualified education expenses. Another HUGE advantage is that the owner of the account, usually a parent or grandparent always maintains control of the assets. This differs from a Custodial account because the money never becomes an asset of the child. Additionally, the owner of the account (parent or grandparent) can change the beneficiary and the parent may get a state income tax deduction for it.

Why is this important? Let’s assume there is a household with three children. The first child is a remarkable athlete or scholar and receives a full scholarship to the school of their choice. If money was invested in a 529 plan, that account can be used for this student’s brother or sister. If the money had been put into a custodial account, the money could not be “reassigned” to another child.

And one more thing to consider: IF the children do NOT need or use the money, the owner of the 529 (usually the parent/grandparent) can take the money out for any purpose and simply pay tax and a 10% penalty on the earnings alone (NOT the principal).

In the example above had the parents or grandparents contributed to a custodial account and not a 529 plan, the child would be in great shape but his or her siblings might not be so fortunate. In essence, the planning done by the parents or grandparents, while genuinely positive in nature, was deficient from a planning perspective.

The long and the short of it is you need to make sure there is enough to go around. Surely everyone wants to make sure their children are financially sound, however, not everyone has unlimited resources. If a household can afford to sock away $1,000 a month for educational expenses, put it in a 529 plan as it can be used for any child/relative.

Are there any other options?

There are many alternatives to 529 plans and traditional custodial accounts to pay for college costs. Below are some additional options to consider.

• Pre-paid State plans: Many states offer discounted payment plans to fund college costs for in-state universities. These are a form of 529 without choosing the investments and can have restrictions on what school you would like to attend.
  
  
• Financial Aid: Most public and private universities offer some sort of financial assistance programs to eligible students
  
  
• Student Loans: Traditional student loans are available through most financial institutions
  
  
• Parent Loans to Undergraduate Students (PLUS loans). The parents borrow the money to pay for their children’s education. Be careful. Remember the old adage, your kids can borrow for college, BUT the parents can NOT borrow for retirement so take care of retirement first.
  
  
• IRA Distributions: Distributions taken from an IRA which are used for higher education expenses are subject to ordinary income tax but exempt from the 10% early withdrawal penalty
  
  
• Roth IRA Distributions: (This is complicated but worth knowing.) All contributions made into a Roth IRA can be taken out tax free. Earnings from a Roth IRA can be taken be taken out tax free if you are over 59½ and had the Roth account open for 5 years. As with a traditional IRA there is no 10% penalty if the money is used for higher education cost although you may have to pay income tax if you are under 59 ½ in age.
  

As mentioned above, parents need to save for their own retirement as well as their children’s college. Though not easy for most families, it can be done as long as you start saving early (for both) and have a plan on which to act.

This short article has outlined the basic concepts and options for college funding. Should you wish to discuss setting up a plan to pay for your children or grandchildren’s education or explore available options, please feel free to give us a call.

<< Return to the Main Street Monitor E-Newsletter