Jason Flurry, CFP
Which college savings account is best?
Comparing your options so you can make the best choices for your family
When I first became a financial advisor, I was trained and a lot of different areas, like retirement planning, estate planning, investments, and income taxes. The big focus in all of my training was on retirement - how to get people there and keep them there without worrying about running out of money before they ran out of breath. For the first 10 years or so, I was doing very well and succeeding at helping people reach those retirement goals. The problem I noticed though, is that retirement wasn’t the only goal people had. College was also a very significant goal for a lot of my clients and I soon realized I had no real solutions to provide that could help make college affordable or show them how to pay for it without creating a strain on their lifestyle or adding stress to the retirement plans.
I had children of my own, so college was on my radar just like it was for my clients. I started asking around to get advice on how I could do better for my own family and help clients achieve their goals in this area too. What I found was that accountants, the firm I was working for, friends and family, other financial advisors, and even the school counselors had ideas… but none of them had anything that I felt confident was the real solution.
What I also realized was that the advice most people are given, to save for college, was good advice, but the way it was being handled was costing people tens of thousands of dollars they could’ve otherwise received had they known better. I was also seeing my clients make foolish financial decisions because I didn’t know how to help them do any better when it came to paying for college.
The turning point That’s when I decided that solving the college dilemma was a very important skill I needed to learn. And as I begin teaching myself how to play the college’s game, I realized that much of what we’ve been taught about planning for college and saving for college is dead wrong. Just like much of the investment advice people receive benefits the brokerage firm and the broker at least as much or more than it does the client, saving for college the traditional way often benefits the colleges and the government more than it does the parents who were trying to do the right things in the right ways for the right reasons.
So that you don’t make the same mistakes that other people do, I’ve decided to share with you today and article from my college planning experiences. This particular article and others like it can be found at www.MyCollegePlanners.com if you’re interested in learning more. This time I’ll be discussing which college savings account is best, and if you have kids your planning to send college or if you know someone who’s planning for college, even if college is still a ways off, this is information you really need to know.
Here you go… Enjoy!
Everyone knows you’re supposed to save for college and save for retirement, but like a lot of other things related to planning for your future, nobody tells you exactly what to do to get the best results. As you probably know, there are several savings vehicles you can use for retirement and for college. Each one has its own benefits and burdens, and for the purposes of this article, I’m going to focus specifically on the college planning part. But here’s the big question most people have - Which college savings plan is the BEST one for you to use so that you get the kind of outcome you’re looking for?
Before we can answer that we need to look at what your goals are and then back into the right options for you from there.
Are you taking advantage of the advantages? Let me ask you a question. If you’re saving for college, does the account you set up have to be a traditional college savings account, like a 529 Plan or a custodial account? Think about it for a minute. Can’t you save for college in a regular account just as well as in a formal college savings account? Of course you can. So why does everybody choose to save in college savings account when they think about saving for college?
Usually the answer is “tax advantages.” And that’s the right answer in some cases.
In 529 plans and custodial (aka UTMA and UGMA) accounts, the IRS allows certain tax breaks that can be helpful to some people. With a custodial account, the interest and dividend income the account earns is taxed at the child’s rate and there’s a certain amount of income that’s exempt from being reported at all. You may have heard of this benefit before. It’s often referred to as the “kiddie tax.” Exempting thousands of dollars of income and gains over the years can really add up if the account is growing steadily and help you keep more of the funds in your account instead of in Uncle Sam’s pocket.
The 529 Plan also has tax advantages when you fund a plan based in your home state and use the money to pay for certain qualified expenses. Most people know you can use the money in 529 Plans tax free to pay for college expenses, but not all college expenses are considered qualified, so be careful and consult with your tax professional to make sure you don’t get a nasty surprise on your 1099 form come tax time.
Recently the rules expanded to also allow parents to pay for private school tuition and a few other expenses related to education with 529 Plan funds too. This trend may continue in the future, so if you have a good amount of money in these plans, educate yourself frequently on the rules. By thinking ahead, you can max out the benefits these plan offer and leverage your savings efforts easily and economically.
Does it makes sense to prepay? In the 529 Plan category there’s another version of the college savings account – the prepaid college plan. Most of these accounts have varying levels of contribution based on what level of benefits you want to purchase and they can be used, in full or in part, at colleges all over the country, even if you move away from the state where it was purchased. You can also lock in “in-state” tuition rates through plans like these, which gives you at least two states to work with on an affordable basis if you’re going to be looking at public universities as your kids’ final college choice.
To trust or not to trust Another type of college savings account that has tax advantages is trust accounts. These are often set up by wealthy families or by extended family members giving money to grandchildren, nieces and nephews, etc. These accounts usually have very strict rules on what the income and principal can be used for and if the investments earn too much money compared to what is distributed each year, the taxes on those gains can add up quickly since they’re taxed at higher rates than individual gains.
The hidden truth you really need to know In each of these account types, there are benefits and burdens to consider, but one major burden to recognize here is that all of these college savings options are considered “student assets” in most financial aid formulas. Parents have a savings allowance they can keep and manage without it counting toward their expected family contributions. A student’s savings allowance, however, is zero. And the percentage the financial aid formula uses to capture those assets is more than three times higher for a student than it is for parent assets. The college won’t necessarily tell you that, but when you report these funds they will count them accordingly. Your financial aid award will likely be less than you expected and you won’t ever know why they felt you could afford to pay so much for college each year. But now you know why. And there’s still time to do something about it.
The solution Fortunately, there are some options on getting the money out of these accounts and into other options that could significantly increase your eligibility for financial aid and save you thousands. And that takes me back to the beginning of this article where I asked the question about saving for college in college savings account vs. other regular savings accounts. Just holding funds in your name as a parent instead of savings in accounts colleges attribute to your kids could drastically lower your expected family contribution. But moving those funds to account types that don’t count against you at all in the financial aid formula could make those savings dollars disappear from the financial aid office’s radar altogether. That’s another whole article for another time, but if you’d like to learn more about these options sooner rather than later, email me at hello@MyCollegePlanners.com.
Balancing grief to rewards There are definitely ways to save for college that are more efficient and potentially more rewarding than going the conventional route of college savings plans. Plus, weighing out the tax breaks you get in college savings plans vs. the amount of lost financial aid having some of those accounts would trigger can help you determine if having a designated college savings account is worthwhile for your family’s finances at all. After all, nobody is in the 100% tax bracket (although it may feel like you are sometimes). So saving 20-30 cents on the dollar in taxes in exchange for forfeiting a full dollar of free money for each extra dollar of expected family contribution you declare is a losing game every time. Did your accountant or investment advisor mention that to you when you were setting up your 529 Plan? My guess is – probably not.
College savings accounts can be good choices for some people who aren’t going to qualify for need based aid. They can help you mentally categorize your savings so you can keep track of your saving goal more easily. But, if you’re successful financially and disciplined with the way you manage your money, earning tax free income and having tax free and penalty-free access to your savings any time you need it could provide a much bigger benefit. Not everyone qualifies for a plan like this, but if you’re in this category, it’s definitely worth your while to check it out. (Again, if you want more info on how it works, email me at hello@MyCollegePlanners.com. I’ll show you how you can save for college AND save for retirement in a way that protects your money from the financial aid formula altogether and gives you flexibility and guarantees none of the traditional plans offer.)
One thing leads to another Saving for college is definitely important. I don’t think it’s more important than saving for retirement, but for most folks, college tends to happen first. And, messing things up for college by overpaying or missing out on aid that could have been (and should have been) yours can have a nasty carryover effect on retirement. Likewise, getting the college piece right can add tailwinds to your retirement plan sails and move you forward toward a life of financial independence and peace of mind faster than you imagined possible.
Learn how to get the college savings decision right and then watch your savings work for you as you approach some of life’s most important milestones. This approach is definitely the smartest way to plan, and since you’re reading this article, I know you’re a smart person. Think about it. Following the pack will never lead you to winner’s circle. You have to be ahead of the pack and take initiative to capture the prize. Run your college planning race to win it and let me know if I can help you in any way. I believe you can do it and I wish you the very best of luck and success as you do!
Becoming an educated consumer I hope you found that eye-opening. Unless you’ve done a lot of research on your own, I’m guessing this is probably the first time you’ve been exposed to those ideas. I’m confident it can help you make college more affordable and keep you in control of your finances when it comes to paying for college. Like I said, college is often the last major goal that has to be met before someone can retire. If you get it right, it can be one of the most rewarding and enjoyable experiences of your life. If you get it wrong though, it can be unforgettable for entirely different reasons and that can cast a dark shadow over your retirement, especially if you’re still paying off student loans during your golden years.
If you’re a parent or grandparent and saving for college is on your radar, you owe it yourself to become a more educated consumer when it comes to how colleges view college savings accounts. I want to make sure that you don’t get penalized for doing the right things simply because no one’s ever told you the truth about how to get the most free money for college possible. I have a lot of free resources available for you at www.MyCollegePlanners.com, so check them out soon.
Building a sound college plan in the context of your overall life plan is something most financial advisors can’t do. It’s what we’ve done for decades though, which has allowed thousands of people to be better off financially AFTER paying for college than they were before college began. It is possible to provide a great education for your children AND continue to build a great future for yourself. And now you know a little bit more about how to make that happen. Keep learning and let me know if we can help answer any questions about college or otherwise. We can help put you on the right path and give you the peace of mind you deserve when it comes to your family and your finances.