As financial planners when one of us announces they’re expecting a baby congratulations are often followed by, “so when are you opening a 529 educational savings account?” College education is a big decision that we all have different takes on. Some people want to fully cover costs for their children, while others envision for it to fully be the child’s responsibility. Regardless of which camp you fall in, being well educated on the cost of education as parents, grandparents, and students will help keep the focus on the education itself rather than financial stress.
Despite our playful question asking coworkers about their 529 plans, for parents we recommend the focus stay on your own retirement before saving for college. While there are loans, scholarships, and grants for school, there are no such resources for retirement. When deciding how much to save for education consider:
Total income – Retirement savings – Living expenses = Money available for college
Where do you get started?
How much you save and how it’s invested will depend on your child’s age and expected costs. The younger your child the more risk you can take in their portfolio at the beginning and then tapering down on risk as your child gets closer to college. In addition to tuition, education costs include room and board, supplies, commuting, and other required enrollment fees.
One of our clients shared that as their babysitter began to talk about college, they took the opportunity to talk about it to their kids who were in middle school and grade school at the time. This gave their kids context for the decisions their babysitter was considering, and it gave our clients a teaching moment. It’s important that you take the time to discuss with your partner whether you foresee your children take loans, work, or apply for scholarships. The earlier you start having these conversations the better because once you have a joint vision, it will be possible to prepare for your child for this decision.
Considering your Saving Options
If your children are less than five years from college and you are concerned about being able to cover their costs, focus saving into the oldest child’s 529 plan. A 529 plan is a tax preferred account that does not tax earning s when they are used for qualified expenses. Some states allow contributions to 529 plans to be tax deductible for state taxes. For information on your own state check out the following website. <https://www.savingforcollege.com/article/how-much-is-your-state-s-529-plan-tax-deduction-really-worth> Money left in a 529 plan after a child is done with college can be rolled into a younger family member’s account without incurring a penalty. If funds are used for non-educational needs, earnings are taxable and they incur an additional 10% penalty.
When applying for college students also complete the Free Application for Federal Student Aid (FAFSA) that determines the family’s expected family contribution (EFC). A student’s income is factored into this and can reduce their eligibility for aid. Funds gifted to students by a grandparent’s 529 plan or a family trust will be considered the child’s income two years after the gift. Because of this, it’s best for those funds to be saved for the last two years of school when they would no longer be counted on a child’s FAFSA. Check out our previous post <http://www.rtdfinancial.com/blog/education-529-plans-parent-versus-grandparent-ownership> for more details on 529 plan ownership.
Although we rarely advice it, there are cases where it makes sense to use retirement funds to pay for college. For example, when someone has a large pension for their retirement or does not want to leave a large inheritance for their kids. This decision should not be taken lightly as there are guidelines on how much can be taken from retirement accounts without incurring fees.
There are many different things to consider when getting ready for college, whether you have a newborn or a senior considering their choices. With college costs rising at about 5% a year it may no longer be feasible to pay for expenses out of cash flow like it was 20 years ago. Financing college, and in some cases K-12 private school, is possible with clear guidelines and conversations. If you or someone you know is grappling with stress around education costs please reach out to us for a further discussion.