Most people want to save for their children’s education but what is the best strategy?
There are three different savings strategies from which you can choose:
1) save for 100% of all education costs so that your child has no liability
2) save a specific dollar amount and leave the remainder for your child, and
3) target a specific percentage of the cost leaving the remainder for your child
This is entirely a personal preference and while there is no entirely right or wrong answer, we encourage clients to avoid sacrificing retirement savings for education savings. Before deciding, first ask:
What are your costs?
The current cost of college education can be easily quantified - the US Department of Education offers detailed cost information on most universities. Here is some recent data on a few well-known universities:
Note that these are approximate costs from 2015 and if your child will not be going to school for many years, then you will need to factor the cost inflation. The inflation rate can vary wildly, from as little as 2% to as much as 7% or more, and will have a substantial impact on your savings plan.
These accounts have the virtue of tax-free earnings as long as the funds are used for qualified educational expenses. Certain states offer tax benefits for contributions as well. Annual contributions are subject to gift tax rules which, for 2017, are $14,000 per person. This means that a husband and wife can each provide a gift of $14,000 to the same child each year; essentially, a $28,000 annual cap. Consult your CPA regarding larger gifts.
529 accounts have distinct advantages but two significant drawbacks:
1) Use of the funds is restricted to educational expenses. If 529 account funds are used for anything other than qualified educational expenses, the amounts will be subject to taxes and, possibly penalties.
2) The investment rates of return are often unimpressive due to limited investment options and account fees.
We advocate using 529 plans as an important, but perhaps not the only, savings vehicle. To supplement 529 savings, consider utilizing a personal, taxable investment account.
Personal Investment Accounts
Investing funds using a personal or joint account offers substantial appeal. You have a nearly unlimited array of investment options so that you can maximize your returns. Further, the funds can be used for nearly any purpose such as education, life events and unforeseen expenses. The caveat is that returns are subject to Federal and state income taxes. Accordingly, you should invest with great care so that you garner a desirable after-tax rate of return.
The more unsure you are about your child’s college costs, the better it is to invest in flexible, personal investment accounts.
Drawing down cash from your home equity or cash value life insurance are options but you may be better off leaving the equity to pay for future retirement expenses. Certain advisors may suggest using your IRA’s for education planning but we discourage this strategy in nearly all circumstances.
#1 Establish a strategic plan as early as you can.
#2 Invest your money carefully and look for safer options as your child gets closer to their college years.
#3 The greater the uncertainty regarding the cost of education, the greater flexibility you will need from your savings plan.
#4 Monitor your savings and educational costs on a regular basis.
#5 Seek guidance from professionals as needed.
In part 3, we will shed some light on education loans, grants and scholarships!