Janney’s Head of Investment Solutions, Jessica Landis, walks through both the commonly known college savings solutions and a few solutions that you may not have yet considered to help you determine the college savings strategy fit for you.
When it comes to parenting, the days may be long but the years are certainly short. Before you know it, your little baby is wearing a cap and gown and heading off to college. Thinking about saving for that day can be a daunting task — especially
with the rising cost of tuition and the many options available. The average 4-year public school costs $22,610 per year for in-state students and the average 4-year private school costs $49,750. (Source: Janney’s College Savings Planner)
Once you know approximately how much you need to save, where should you put it?
Using a 529 plan has many different benefits for families including the potential for tax-free growth and withdrawals
if the funds are used for qualified education expenses, the potential for a state income tax deduction for contributions, flexibility if you’re planning for multiple children, and control for owner of the account.
Options for Use of the Funds
If you don’t use the money saved in a 529 plan for your child’s education, there are options. You can change the beneficiary to you or another family member for their education or pay a 10% penalty and income taxes on the growth to use
the money for other purposes. The owner of the account retains control of the money.
How 529 Plan Funds Affect FAFSA Calculations
If the account is owned by the parent, 5.64% of the balance is counted toward the student’s
FAFSA calculation. 529 plans owned by grandparents are excluded from the FAFSA calculation until distributions are taken which are then counted as income for the student. This can be avoided if grandparent 529 plans are used for the final 2 years
of a student’s education.
A 529 plan account is a nice solution for families who specifically want to save for college, want control over the use of the funds long-term, and are looking for tax preferred treatment for their college savings.
A UTMA/UGMA is a custodial investment account that a minor can own. You can contribute an unlimited amount to these accounts on behalf of the beneficiary, and the money can be used for
any purpose (education, wedding, home down payment, etc.) offering a great deal of flexibility. The money can be invested in virtually any asset (stocks, bonds, mutual funds, etc.).
Taxation of UGMA/UTMA Assets
gains are realized, they are taxed on the child’s income tax return and kiddie tax applies. Contributions are irrevocable gifts to the child and cannot be taken back to be used for another relative or goal. Once the child reaches the age of
majority in their state (18-21), the account becomes theirs and they can use the money however they choose. Because UTMA/UGMA accounts are an asset of the child, their expected contribution (EFC) is 20% of the balance compared to 5.64% if the asset
was held by the parent.
Rolling Over Assets into 529 Plan
UTMA/UGMA accounts can be rolled into a custodial 529 plan as long as the title on the 529 plan matches the UTMA/UGMA account. This may result in having the assets treated as a parental
asset instead of a child’s asset for the purposes of FAFSA, depending on whether the child is considered a dependent or not. When the child reaches the age of majority, they will then own the 529 plan and can still use those funds as they choose.
This option provides a nice solution for parents or family members looking to give money to the child for college but also wants the money to be able to be used for other purposes outside of college.
A non-qualified investment account owned by the parent/grandparent is also a solution for college savings. This account allows for unlimited contributions by the owner, remains in the owner’s control, can be used for other financial goals
if not needed for college, and is only taxed as capital gains at the owner’s capital gains tax rate as gains are realized. This account does not offer any specific tax benefits for contributions or withdraws used for college planning. If the
investment account is owned by the parent, 5.64% of the balance will be considered the EFC in the FAFSA calculation. This may be a solution for families with multiple competing goals (i.e. college, vacation home, etc.) who want ultimate flexibility
and control and/or as a supplement to saving in a 529 plan or UTMA/UGMA account that is designated for the child’s educational use.
Life insurance can be a solution for education planning as
well. A cash value, permanent life insurance policy can be taken out on either the child or the parent depending on the goal of the family. A portion of the premium paid into the policy will accumulate as the policy’s cash value over time and
will grow either through dividends paid on the policy or based on the underlying investments in the policy depending on the type of policy you choose.
Options for Use of the Funds
The policy’s cash value grows
tax free and a tax free loan can be taken against the policy and used for college education. If the child is insured and doesn’t use the money for college, the cash value can continue to grow and be used for any future need (home down payment,
start a business, etc.)
Death Benefit Options for Use of the Funds
The death benefit can be used in the future for protection as they grow their own family which can be especially helpful if the child has medical
issues in the future (i.e. diabetes, heart issues, etc.) and has trouble obtaining insurance as an adult. If the parent, grandparent, or guardian is insured, they too can use the cash value in the future for any purpose. If the cash value is never
needed, the death benefit can be a tax free inheritance to their heirs or charity. Cash value of life insurance is not included in a families EFC for the FAFSA calculation.
While a Roth IRA is not often
considered an education funding vehicle, it can be used for that purpose. Contributions to a Roth IRA can be withdrawn any time and are always tax free. For parents who will be 59 ½ or older when their child attends college, withdraws of earnings
are also tax free if a 529 account has been opened for 5 years or longer. For parents younger than 59 1/2, the early distribution penalty of 10% is waived if the withdrawal is used for college expenses, but income taxes on the earnings will apply.
The max contribution for Roth IRAs is $6,000 in 2019, earned income is required to make a contribution, and AGI limits apply.
A Roth IRA balance does not count toward the family’s EFC for FAFSA purposes but distributions will count as untaxed income for future FAFSA applications. Keep in mind, using a retirement account for education can jeopardize your retirement plan and reduce your retirement income options to help manage your taxable income in retirement.
There are several important questions you’ll want to ask yourself to get started. What type of college education do I want to cover? Will I pay 100% of that cost or will be child or other family members be expected to help? If my child doesn’t need the money for college, will I want to use that money for another goal, will I want my child to have it as a gift, or will I want to control the money and give it to my child (or others) as I’m comfortable?
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