Recently, a family friend asked, “How in the world can we possibly pay for our kids to go to college?”
I was lucky enough that I graduated without any student loans – thanks Mom and Dad ❤️.
My wife unfortunately was not as lucky.
One of the main priorities in our family is to ensure our children can get a quality education.
If they choose to go to college, we want to be prepared for that.
Should they not go to college and want to start a business or different endeavor, we want to be prepared to help for that as well.
We’re doing this through a 529 College Savings Plan (you’ve likely heard of them).
The Pros:
☐ Contributions grow tax-free deferred
☐ The growth can be distributed tax-free for qualified education expenses
☐ If the 529 is open for 15 years, unused portions can be rolled over to a Roth IRA for the child (Eligibility criteria must be met. Annual limits apply. Lifetime limit is $35,000)
The Cons:
☐ Non-Qualified distributions are subject to a 10% penalty
☐ Investment limitations
I live in Lancaster, SC, and hope that if our children decide to go to college, they can take advantage of an in-state institution.
I will use the University of South Carolina as a proxy.
Today, the average cost of attendance for the University of South Carolina (after aid) is $20,796 annual in-state (includes room & board).
We currently have a 10-year-old, so we may only be eight years away from this unfolding.
Assuming a 6% annual increase for the cost of college, his first-year cost would be $33,146. The total cost for four years of would be $145,000!
The Lump Sum Approach:
☐ If we had $79,509 today in a 529 Plan growing at 7.8%, we would have $145,000 by the time our oldest entered college. More importantly, we would not have to make any additional monthly contributions.
The Systematic Approach:
☐ Let us assume that we currently have $23,000 in a 529 Plan. We would need to contribute $770/month to have $145,000 by the time our oldest entered college. If we decided to stretch that out for an additional four years to contribute while he was in college, it would lower the monthly contribution to $365/month.
This note is a painful reminder that we’ll be planning for not one college education, but three! Wow!
A Few Notes:
Ongoing financial planning is critically important to keep up to date with all of the legislative changes that occur over time (like the Roth IRA rollover provisions, etc…).
There are other options that are available to fund your children’s education:
☐ Investing in a brokerage account
☐ Investing in a custodial account (UTMA/UGMA)
☐ Utilizing cash value life insurance
☐ Purchasing a rental property
There are pros and cons to each of these options, but it all starts with understanding what is most appropriate for your family’s unique situation.
Nic Notes:
☐ 529’s can be used to pay for college, but also: vocational, trade, elementary, or secondary school tuition.
☐ 529’s can also be used to pay for student loans (lifetime limit of $10,000).
☐ 529’s can be used to pay for books and supplies, computers, and room & board, but only for college.
☐ What is the worst-case scenario? If you have a beneficiary that does not go to college, you can always change the beneficiary without tax consequences if the new beneficiary is a family member of the account owner, the owner themselves, or a grandchild.
In addition, non-qualified expenses will incur income taxes on the earnings portion of the distribution plus a 10% penalty.
If you or someone you’re close to could use help aligning their finances and establishing a financial plan, please reach out to us, we’re accepting new clients and eager to help.
Cheers,
Nic
Disclosure: Prior to investing in a 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
