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Randall Financial Group News

01-Jul-03

Saving for a College Education

I was attending my daughter’s first graduation a couple of weeks ago. This one was from preschool and I was beaming with pride as she sang songs and showed me all of the art projects she had worked on during the year. Despite my joy at seeing what she had accomplished, I couldn’t help but think about another graduation roughly fourteen years down the road. That one would be from high school, and a couple of months after that I would get a bill that would make my property taxes look cheap, her first year of college tuition.

As a financial planner this is often a topic with which I help clients. After saving for retirement, paying for the college education of a child or children is one of our largest investment goals and the cost can be staggering. According to the web site www.collegeboard.com, just one year at the University of Rhode Island with room and board currently costs $12,351 dollars. A four year degree would be nearly $50,000. Now if you’re like me and have a young child with say 14 years to go before college and you factor in a five percent annual increase in college tuition costs, then get ready to pay over $100,000 for all four years. If your child is lucky enough to get into Harvard where one year of tuition, room, and board is currently $36,000 then your tab for an undergraduate degree could be a whopping $288,000 by the time your 4 year old enters college.

How are you going to pay for that mega bill? Well, scholarships and financial aid can help, but unless your kid is the next Tiger Woods or Mia Hamm then you or your child are probably going to have to pay something. Fortunately, there are some wonderful college savings programs available that help you get the biggest bang for your buck. The key is to figure out which one is best for you, start early, and save often. What follows is a brief description of several plans, their advantages, and disadvantages. With disciplined savings over time and some help from one of these plans; that college education is well within reach.

529 Plans. 529’s are a relatively new and very popular way to create that college savings nest egg. 529 refers to the section of the IRS code which allows these vehicles. They are savings programs run by the State to encourage college savings. Each of the 50 states now has at least one plan. The plans come in two basic types, either pre-paid or savings. A pre-paid tuition plan allows you to lock in the future price of an education by paying in dollars today. You pay upfront and lock in the cost of tuition, typically at a state school.

The more popular savings plans allow you to invest money on a tax favored basis for future education expenses. 529 plans have some significant tax advantages. Any money deposited into these plans grows on a tax deferred basis like your IRA. More importantly, the funds withdrawn to pay qualified higher education expenses can be taken out tax free. The problem is the tax free withdrawal feature is scheduled to end in 2010. Its future after that is uncertain and depends on Congress extending the benefit. The Rhode Island plan is administered by Alliance Capital and although you don’t have to go with your state’s plan, the Rhode Island plan allows residents to deduct up to $1,000 per couple on their state income tax return. You can enroll in the Rhode Island plan through a financial advisor or by contacting Alliance directly at 888-324-5057. 529 plans all offer a variety of investments and usually have some type of age weighted portfolio which shifts the investment allocation to more conservative choices as the student approaches college age. 529 plans offer a great deal of flexibility including the ability to change the beneficiary of the plan at any time in case the original beneficiary decides not to attend school or does not need all of the money. You can also take the money back but beware: you’ll be assessed income taxes and a 10% penalty on your gains.

UTMA/UGMA. Uniform Transfer to Minors and Uniform Gift to Minors accounts are one of the older college savings vehicles available. They allow a parent or other adult to transfer money into a child’s name but retain control over the account until the child reaches the age of majority. The advantage from a tax standpoint is that taxation of the account will be at the child’s tax bracket which may be less than the parents, depending on the child’s age. UTMA’s and UGMA’s can be established at banks and brokerage firms and can invest in just about anything. The disadvantages of these accounts however, often make them less attractive than the alternatives. Keep in mind that when your child reaches 18, they can do whatever they want with the money because it’s theirs. You may want them to attend college, they may want to buy a motorcycle; it’s up to them. The other problem is that by putting the money in their name you might adversely impact their chances of receiving financial aid. Money in the student’s name is expected to be used to pay for their education at a higher percentage than money held in the parent’s name.

Coverdell Education Savings Accounts. Formerly known as education IRA’s, these accounts have become more attractive with some recent tax law changes. With these accounts a parent or other interested party can contribute up to $2000 per year into the account. The attraction is that the growth is tax deferred and funds withdrawn to pay for education are usually federal income tax free. I say usually because it depends on whether you took a hope or lifetime learning credit on your tax return. Education Savings Accounts can be set up at banks or brokerage firms and can invest in a variety of different securities. There are some income limitations which prevent high income earners from contributing and the beneficiary student must be 18 years old or younger when contributions are made. In addition, all of the distributions must be made to the student by the time they are 30. Unlike a 529 plan, you can’t take the funds back once they are placed in the ESA. Eventually they will become the students.

For more great information on college savings plans check out www.savingforcollege.com. For information on the Rhode Island 529 plan you can go to www.collegeboundfund.com. The website also has a great calculator to help figure out what 4 years at the college of your choice might cost when your child is ready to attend. If you have a question for me about this topic or any other on personal financial planning, you can email me at otutt@blackstonecapitalRI.com or call me at 401-228-0100.

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