Stock Up on School Supplies… and Savings

I love this back-to-school time of year when the air feels a touch cooler and the nostalgic scents of sharpened pencils and brand-new books are in the air. Now that the kiddos are headed back to school—whether in a classroom or through a computer screen—it makes sense to start thinking ahead to college.

As I mentioned in a recent post, putting a little money aside now can make a big difference in growing your savings. If you have children, it’s a good idea to put some of that money toward their education. The cost of higher education has never been higher than it is today, and this year, Forbes reported that student loan debt in this country hit a whopping $1.56 trillion, an all-time high. The average student loan debt for the class of 2018 is $29,200.

As a Personal Financial Specialist, education savings planning is one area in which I assist clients. And the best and most important advice I can offer is to start as early as possible.

529 Plans: Facts and Misconceptions

About one-third of parents (29%) use 529 college savings plans to save for their kids’ college, according to Forbes. They get their name from Section 529 of the IRS tax code, which authorizes tax-free status for qualified tuition programs. These plans are what we call “tax-advantage” plans. So yes, there is a tax benefit involved, but a common misperception is that the advantage happens immediately. It doesn’t.

A 529 is similar to a Roth IRA in that you deposit funds that have been taxed—your net income—so that when you withdraw the money later, you owe no taxes on it. Any appreciation of that investment is also tax free. But while the Roth is a retirement account, the 529 plan is to be used only for educational purposes at accredited institutions. This can include tuition, fees, room and board, books and supplies, and even student loan repayment (some other fees, such as transportation and cell phone expenses, don’t qualify).

What if your child decides not to go to college? Unfortunately, that complicates matters. The unused money can be withdrawn with a 10% penalty (account appreciation only—the money you put in will be returned for free), and it will be subject to income tax. However, you can roll it over to another account with a different beneficiary—perhaps a younger sibling or parent who wants to attend college.

Changes implemented in 2018 mean that 529 money can now be used for K-12 education as well, such as at private schools. But just because you can doesn’t mean you should—I don’t recommend this. In my experience, the benefit of a 529 plan comes from watching an investment grow with interest. Allowing the fund to mature is the best way to maximize its benefits, so withdrawing it while your child is still young cuts short that maturation period, and it reduces the amount available for higher education, where expenses are vastly more substantial.

I’ve also seen from experience the benefits of having a 529 plan on a child’s interest in college. There’s something about knowing the money is there and that, because of it, college is a possibility—it encourages a student to consider it and eventually enroll. For this reason, I recommend starting one. It’s a great gift idea for grandparents or other relatives or friends. Families should talk about it, regularly add to it, and share the benefits with their children so they can develop an appreciation for this helpful savings plan.

Prepaid Tuition Plans

While a 529 plan is portable and can be used at any accredited college or university, a prepaid tuition plan is a state-specific tool designed to increase a state’s college-going rate, with the enticement of paying now to save money later.

At its most basic, the concept is simple: You pay today’s tuition rates now, and when your child reaches college-going age, he or she can attend college at no cost, regardless of how much tuition may have grown. That’s no small savings: In the last 10 years, the cost of college has increased by 25%. By locking in today’s rates, you save in the long run.

Currently, 18 states offer some form of prepaid tuition plan, though individual states differ. Typically you can pay either all at once, for two or four years, or through a payment plan. You lock in your tuition rate at the time of purchase, and no matter what tuition costs when your child finally attends college, it doesn’t matter. College is still entirely paid for.

What if your child wants to attend an out-of-state school? That’s okay, but the benefits are mitigated. You’ll get only the value of the investment put toward the tuition, and no more. In other words, if you paid $25,000 and your child decides to attend an Ivy League institution out of state, that $25,000 is his, but that may only cover his first year (if that). Nonetheless, having college already paid for is a huge enticement for a student to attend college, so it’s likely to be a powerful and well-used investment.

If back-to-school time has you thinking about education savings, schedule an appointment with us today. We can advise you what to do when you use multiple sources to pay for college: 529 plans, grants, and student loans—which can get tricky on tax returns—as well as help you assess whether such plan is advantageous to you.

In the meantime, I wish you a happy fall and a healthy, enjoyable back-to-school season!