Saving for your Children or Grandchildren’s Education

coins in a jar labeled college fundWith tuition prices continuously on the rise, saving for your children’s or grandchildren’s education can seem like an insurmountable task. If you are feeling this way, you are not alone; according to a national survey by Sallie Mae in 2018, just 56% of parents are saving for their children’s education expenses. These savings hold an average amount of around $18,000.

Between paying off a mortgage, car loans, and perhaps even your own education expenses, saving for your children or grandchildren’s education is a challenge, but is proven to be worth it. Studies from the Bureau of Labor Statistics and many other reputable sources consistently show that there is a positive correlation between income and level of education. So how do you begin saving for education expenses and what are the best ways to do so?

Starting to Save for Education Expenses

As with any investment, financial planners believe that the key to success is to begin saving as early as possible so that your investment has more time to compound earnings and grow. Contributing what you may deem to be a small amount will always be better than contributing nothing at all. These contributions, no matter how big or small, will allow you to take advantage of compound interest and keep your savings growing.

Popular Options for Saving for Education Expenses

529 Plan

A 529 Plan permits parents or grandparents to invest after-tax money into diversified mutual funds, which can then be withdrawn without taxation for qualified education expenses. The funds in the account grow tax-deferred until the funds are withdrawn. At that point, if the withdrawal is used for tuition and related expenses, they are not subject to federal capital gains taxes. Most states do not tax the gains, either.

It’s important to note that money held in a 529 Plan can only be used for education-related expenses. These include undergraduate and graduate tuition at accredited colleges in the United States, college fees, textbooks, and sometimes room and board expenses.

There are two different types of 529 Plans. Some 529 Plans are sold directly by the state and others can be sold through a financial advisor. The direct-sold plans often have lower investment fees, but they also come with less flexibility in terms of investment options. The plans offered through financial advisors have more options for investments. Additionally, some of these plans may allow the account holder to shift the beneficiary to a different family member, although restrictions may apply. Usually, there is no restriction on the account holder’s income or the beneficiary’s age.

students wearing caps and gowns for graduationPrepaid Tuition Plan

Our experience has shown that it is best to select a prepaid tuition plan only when you are reasonably confident that your child or grandchild will be attending college at a public in-state university. The prepaid tuition plans allow you to purchase “units” at participating universities at current tuition prices for the beneficiary to use in the future. So, if tuition at an in-state public college is $15,000 per year, your contribution of $7,500 now will provide your loved one with one semester of college when they enroll, even if the tuition has increased to $20,000 or more per year. While there is less flexibility in where the funds can be used, this is a way to help cope with the ever-increasing tuition costs by locking in the tuition cost at the time of contribution.

If your child or grandchild decides to go to a college out of state, they will not get the full value of the plan. They will receive back the money that was initially paid in, but they will not have the advantage of locking in the tuition price from when you began contributing.

students in caps and gowns for graduationCoverdell Education Savings Account (ESA)

You can open one ESA per child and contribute up to $2,000 after-tax per year. Rather than opening a traditional low-interest savings account, opening an ESA will typically earn you a higher rate of return and provides similar tax advantages to the 529 plans. The money your child or grandchild withdraws to pay for education expenses is withdrawn tax-free.

These types of accounts do come with certain limitations. Your income must be below a certain level in order to be eligible to make contributions to an ESA. The contribution amount is limited to $2,000 per year per beneficiary. Once the beneficiary reaches age 18, no more contributions can be made. Also, everything in the account must be withdrawn by the time your child or grandchild reaches the age of 30.

Trust

The main benefit of opening a trust is that you have complete control over the terms of use. While more time-consuming to set up, you can structure the trust terms to your liking. You can specify that the funds only be used to cover tuition expenses, or you can be more flexible and broaden the terms to include room and board, transportation–even an allowance for a break from hitting the books. This flexibility and control comes at the cost of losing the tax advantages provided by the 529 or ESA accounts. The beneficiaries will likely pay income tax on the fund’s earnings.

Uniform Transfer to Minors (UTMA) or Uniform Gift to Minors (UGMA) Custodial Account

This may be a more familiar type of account when thinking about ways to save for a minor child or grandchild. Account holders contribute directly to the account in their child or grandchild’s name, investing in whatever they choose. These accounts are not limited to being used only for education expenses.

These accounts are in the beneficiary’s name, but they will be controlled by you, the custodian, until the child reaches the age of majority (18 or 21 depending on the state). Once the child reaches this age, control is legally transferred over to them and they can use the money as they choose. Unlike some of the other college savings plans, the beneficiary of a custodial account cannot be altered once they have been selected.

Saving for your children’s or grandchildren’s education expenses is one of the greatest gifts that a parent or grandparent can offer. If you would like assistance from a financial advisor in strategically planning your education contributions, contact Morris Financial Concepts. We will aim to help you meet your financial obligations while also planning for one of the most valuable gifts you can give.

 

 

The opinions expressed herein are those of Morris Financial Concepts, Inc. (“MFC”) and are subject to change without notice. This material is for informational purposes only and should not be considered investment advice. MFC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about MFC, including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request. MFC-19-13.