Revisiting Education Savings This School Year

As a father of two and Advisor at TCI, saving for my kids’ education is always on my mind. My wife and I try to set a little aside each month so we’re ready for the day the tuition bills start coming in. It’s easy to overlook or put off this part of financial planning, but starting early can make a big difference. Not only can it help ease the costs of education, but it also gives your investments more time to grow, setting your family up for success and giving your loved ones the freedom to pursue their education without financial worries.

What does it really take to prepare for this major financial milestone? Whether it’s understanding different savings vehicles or navigating the costs of higher education, being informed and proactive can make all the difference. Let’s explore some key strategies that can help families make the most of their education savings.

Start With a Goal

Before diving into investment options, my clients and I start by setting a clear educational goal. This step begins with an open dialogue to understand their aspirations and the educational path they wish to pursue. The range of educational options available today is vast–ranging from a 4-year private university to community college to trade school–and each comes with its own financial considerations. It’s important to note that we aren’t trying to come up with the perfect plan, but rather one that charts a certain direction and can be adjusted as the beneficiary and family go through different stages of life.

Unpredictable education costs also leave room for plan changes. For example, your child may decide not to attend college, or they may receive scholarships or other financial aid that significantly reduces costs.

Nevertheless, once you’ve established a clear goal, I like to work backward to determine how much you can realistically save toward education. This is the stage where we align your overall financial plan with your educational savings goals.

In retirement, your income is largely fixed, and borrowing for your golden years isn’t an option. So, we ensure that your retirement plan can help you achieve your goals and that saving for education doesn’t compromise your long-term financial security.

Types of College Savings Plans

While there are several savings vehicles to choose from, the 529 plan stands out as the most common and robust option. This plan offers significant tax benefits, allowing your investments to grow tax-free as long as the funds are used for educational purposes, which includes a wide range of expenses. Additionally, 529 plans provide a variety of investment options, making them a versatile tool for college savings.

In a 529 plan, the account holder—usually a parent or guardian—retains ownership and control over the account, with the student named as the beneficiary. This structure allows you to maintain control over the funds, ensuring they are used for their intended purpose.

An alternative to the 529 plan is the Uniform Transfers to Minors Act (UTMA) account. Unlike 529 plans, UTMA accounts do not offer tax-free growth. Additionally, there are differences in terms of control over the funds. While the account is initially in the parent’s name, once the child reaches the age of majority (typically 18 or 21, depending on the state), they gain full access to the money, regardless of whether they attend college.

Another distinction between 529 and UTMA plans lies in how they are factored into the Free Application for Federal Student Aid (FAFSA). In the FAFSA system, a higher amount of assets generally results in less financial aid. However, 529 plans are not considered a student asset; they are treated as a parental asset, which has less of an impact on the aid calculation. This can help increase the amount of aid the student receives. In contrast, UTMA accounts are considered a student asset, which can significantly lower the amount of financial aid for which a student qualifies.

Understanding 529s

While similar to other investment accounts, a 529 plan offers unique tax benefits specifically for education savings, making it a highly effective tool for education funding. The first step is to invest in the plan as early as possible, selecting an investment fund that aligns with your financial goals and investment style. Each TCI Advisor works closely with their clients to determine which investment strategy best suits their needs.

You can then contribute to the account either monthly or annually, allowing the money to grow tax-free. As long as these funds are used for educational purposes, the growth remains untaxed. Fortunately, the IRS allows a broad variety of expenses under 529 plans, such as:

• Tuition and fees
• Books and supplies
• Room and board (for students enrolled at least half-time)
• Computers and related technology
• Special needs equipment required for education
• K-12 tuition (up to a certain limit)
• Apprenticeship programs

Every state has its own, unique 529 plan, each with its own set of investment options. It’s important to note that you don’t have to live in the state of the 529 fund you choose, nor does it need to be in the state where your child will attend college. You have the flexibility to choose whichever state’s plan best suits your needs.

When determining the right 529 fund, we consider several key factors, including:

• Best investment options
• Ease of use
• Cost of administration

While federal tax rules are consistent across all 529 plans, state taxation can vary. Some states offer additional tax benefits for residents who invest in their state’s plan. For instance, Colorado’s 529 plan offers tax deductions for contributions. We carefully evaluate each state’s plan to determine which one makes the most sense for your residence and overall financial plan.

The investment strategy within a 529 plan should also be tailored to your specific situation, particularly in terms of how aggressive or conservative the approach should be. For example, if you’re saving for a newborn, we might recommend a more aggressive investment strategy, given the long time horizon and the ability to weather market fluctuations.

What Happens If I Don’t Spend My Entire 529?

The rules around 529 plans are designed to encourage spending on education, so if the gains in a 529 account aren’t used for qualified educational expenses, you’ll face some financial consequences. Specifically, you’ll have to pay income taxes on the account’s growth and a 10% penalty on those earnings.

If you find yourself with more money in the 529 plan than you need, it might initially seem like you’re facing imminent taxation. However, there are several strategies to avoid this tax burden:

• Transfer the account to another family member: Qualifying family members can include siblings, nieces, nephews or even yourself if you decide to pursue further education.
• Pay off student loans: You can use up to $10,000 from your 529 to pay off student loans for the beneficiary or their siblings.
• Fund secondary schooling: If your child plans to attend graduate school or another form of post-secondary education, you can use the remaining funds for those expenses.
• Transfer funds to a Roth IRA: A recent rule change allows you to transfer leftover 529 funds to a Roth IRA for the beneficiary. This option has some technical requirements, such as the 529 account needing to be open for at least 15 years before the transfer, and limits on how much you can transfer each year.
• Save it for future generations: 529 plans never expire, so you can keep the account open and potentially use it as a legacy fund for future generations, such as grandchildren.

Guiding You Through the Education Journey

Setting clear goals and understanding your options helps build a solid foundation for education savings that aligns with your broader financial plan. However, the nuances of education savings can sometimes be complex and overwhelming. You don’t have to take this path alone. All of us at TCI are here to help you navigate this path, guiding you toward decisions that make the most sense for you and your child. Let us partner with you to turn your savings goals into a well-executed plan, giving you peace of mind and a brighter future for your family.