by Tim Farley Jr.
Covering the Cost of College? Here are some strategies…
With higher education costs continually rising, the need for planning for these large out-of-pocket costs becomes increasingly important. As a result, there are a number of ways to save for college, each having pros and cons.
For simplicity purposes, we want to break down a few potential options:
529 Education Savings Plans are considered the most prevalent vehicles for funding higher education expenses. The premise of this account is that contributions to this account are on an after-tax basis and all growth is tax-deferred while inside the account. As funds are then used to pay for qualified education expenses, the withdrawals are entirely tax-free.
Depending on the type of 529 plan, different states may offer a state tax deduction or credit on the contribution up to certain limits. Currently in the state of Ohio, up to $4,000 of annual 529 contributions per beneficiary are eligible for a state tax deduction. There is also currently a carry-forward of contributions above the $4,000 cap for the state tax deduction.
As with all plans, there are a few caveats. First, the 529 plan can be used to pay for 100% of college or vocational school tuition and fees. Should a family wish to use the 529 plan for K-12 private school tuition, they can do so up to cap of $10,000 annually.
529 plans can also be used to pay for Room and Board (assuming the student is enrolled in college at least half-time), books and supplies (only ones required for the classes), computer for college only, and any special needs equipment needed for college.
For students that qualify for a scholarship, an amount equal to the scholarship can be withdrawn from the 529 plan penalty free however any growth would still be taxable upon withdrawal. If the owner of the 529 has multiple children, he/she can also change the beneficiary of a 529 plan to another child so funds can still be used for education expenses.
Non-Qualified Investment Account(s)
For many clients, there are concerns around liquidity. If a client does not want to formally lock up funds into a 529 plan, perhaps due to uncertainty of higher education, shorter-term needs, etc., they can instead save funds into a non-qualified account. These are typically individually owned or jointly owned between spouses/partners.
The main value of this account is that it has no withdrawal rules or limits associated with it. Individuals and families can make unlimited contributions each year on an after-tax basis. Depending on the investment strategy inside the account, taxes are only paid on the gains as they are realized. This could be in the form of dividends/interest or capital gains on the sale of a position.
There is no tax-deduction for contributions to this account, however there are also no stipulations on what the funds needs to be used for which makes this account the most flexible investment account option available.
Another vehicle that can be used for education expenses is a Roth IRA. Roth IRAs are typically described as tax-free accounts where there is no tax deduction for contributions, however all growth is tax-deferred and if an individual takes funds out after age 59.5, all withdrawals will be entirely tax-free.
There are income limits to the availability to save into a Roth IRA so we recommend consulting with a tax professional to ensure income limits are accounted for prior to making a Roth contribution.
The caveat to a Roth IRA is that assuming the account has been opened for a minimum of 5 years, all contributions to the account (also known as cost basis) can be withdrawn tax and penalty free. However, all appreciation must stay inside the Roth IRA until age 59.5 or else income tax and a 10% penalty are owed on that growth.
In addition, once secondary benefit to this vehicle is that since the vehicle is a retirement account, the assets are not includable in FAFSA calculations for the student if the parents are filing on their behalf. This can help shield assets from being viewed as available to pay for higher education costs and as a result, could help lower the “family expected contribution” amount.
There are several vehicles that can be used as savings for education expenses. Most individuals don’t limit themselves to strictly one savings strategy but rather have several different accounts to provide flexibility once education costs are due. These options must each be weighed as part of a comprehensive plan looking at the various goals which include protection planning, retirement, wealth accumulation and education planning. Reviewing these accounts during the financial planning process will help ensure a family’s various goals can be achieved in the most efficient manner.
Should you have specific questions about your own planning and would like to consult with our firm, please reach out to [email protected] or via phone at 216-810-5900.
Cleveland Wealth, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.