Saving for college can be intimidating. We know that we’re going to have a large expenditure coming up, but we don’t know how much. Where will they go to college? How much will it cost? College tuition inflation averaged 4.63% annually from 2010 to 2020. Since 2019, the price of tuition, fees, and room and board has been rather flat, and actually lower in some cases. I don’t think that we should plan for that to continue. I have included a list of a few college tuition rates at the end as a guide.
There are several different ways to save for college. I’m going to narrow this article down to 529s and Direct Payments. Under most circumstances, they will be the best options.
529 College Savings Plans
529 plans are fantastic tools that are designed specifically for college savings. Earnings grow tax-free and withdrawals for qualified education expenses are also tax-free. Qualified expenses are tuition, fees, books, supplies, and equipment. Room and board can also be included in many cases.
The owner of the 529 account is often a parent or family member of the beneficiary. The beneficiary of the account can also be changed, so if one child doesn’t go to college or doesn’t use all of the funds in the account, you can change the beneficiary of the account can be changed to a different child, as long as the new beneficiary is in the same generation as the original beneficiary. A student can also be a beneficiary of multiple 529 accounts.
Gifting Ideas for 529s
| Annual Limit Single | Annual Limit Couples | 5 Year Front-Load Single | 5 Year Front-Load Couple |
|---|---|---|---|
| $17,000 | $34,000 | $85,000 | $170,000 |
A contributor can give up to the annual gift exclusion amount each year without incurring a gift tax. In 2023, that amount is $17,000 per person. That $17,000 limit is per person, so a married couple can give up to $34,000 per year without incurring any gift tax liability. Another unique feature of 529 contributions is that a contributor can give up to 5 years worth of the annual gift exclusion amount without incurring gift taxes. The IRS will treat each year as 1/5 of the contribution per year. So, a contributor in 2023 can give $85,000 ($17,000 x 5) to any 529 beneficiary that they wish. A married couple can double that number to $170,000. They would then not be able to give that beneficiary any gifts for the next four years without incurring a gift tax penalty. Any amount given over the annual gift exclusion ($17,000) can be applied to the contributor’s lifetime exclusion, currently $12.92 million per person.
Contributions to 529 plans are not federally tax deductible. They can be deductible at the state level in some cases, but that depends upon the state.
If funds are not used for qualified education purposes, any distributions will be treated as ordinary income, and possibly incur a 10% penalty as well. Beginning in 2024, up to $35,000 can be rolled over a lifetime from a 529 to a Roth IRA tax-free, but there are some restrictions. This does help a little for those that are concerned about overfunding a 529 and potentially having to pay taxes later.
Direct Payments
You can pay for anybody’s tuition or medical expenses directly without it counting toward your annual or lifetime gift exclusion. Yes, you read that correctly. As long as the payment is made directly to an accredited educational institution, that gift is never applied to any of your exclusions. This is the most tax efficient way of gifting for college and reducing the size of your estate. Do not write a check to the student or their parents. The payment HAS to be made directly to the institution.
Investment Allocations
Since we know when we’re going to start withdrawing money from the account, we can thoughtfully plan our investment allocations. When the child is a baby or toddler, we can be more aggressive. The reason being that the longer time frame, the longer we have to make up losses in the event of a market decline. Stocks have traditionally outperformed bonds over longer time horizons, but typically bring more risk. This is the standard allocation for the Schwab 529 Education Savings Plan. Portfolios are not one-size-fits-all, but this is good information to keep in mind.
Stock Allocation of Age-Based Tracks
| Age of Student | Aggressive | Moderately Aggressive | Moderate | Moderately Conservative |
|---|---|---|---|---|
| 4 and Younger | 95% | 80% | 60% | 40% |
| 5-7 | 80% | 70% | 60% | 40% |
| 8-10 | 70% | 60% | 50% | 40% |
| 11-13 | 60% | 50% | 40% | 30% |
| 14-15 | 50% | 40% | 30% | 20% |
| 16-17 | 40% | 30% | 20% | 10% |
| 18-19 | 30% | 20% | 10% | 0% |
| 20+ | 20% | 10% | 0% | 0% |
As you can see, allocations to stocks should decline as you get closer to paying those tuition bills, regardless of how much risk you are willing to take. Remember that this is just a guide. Speak to your advisor about what kind of allocations are right for you.
FAFSA
The Free Application for Federal Student Aid (FAFSA) is used to determine a student’s eligibility for financial aid. It takes into account the assets and income of the child and their parents. Income is more important than assets in this calculation. The student’s assets and income have a higher weighting than their parents. This make 529s a better option than trusts, because 529s are typically owned by a parent or grandparent, while a trust is often owned by the student.
Visit this website to get an idea of how much aid a student may receive.
Tuition, Fees, and Room and Board
| College | In-State | Out-of-State |
|---|---|---|
| University of Illinois | $40,000 | $62,000 |
| Indiana University | $29,000 | $57,000 |
| UCLA | $39,000 | $71,000 |
| Harvard | $57,000 | $57,000 |
| Vassar College | $85,000 | $85,000 |
| Northwestern University | $88,000 | $88,000 |
These numbers all come from the websites of the prospective schools. Total expenses for a four-year school can cost well over $100,000. Saving $4,000 a year for 15 years at a 6% return would bring the account value to $93,000. With some planning and consistent additions to a 529 account, college savings can be more manageable. The sooner that you start saving, the less stress you’ll have when your child starts filling out college applications and touring schools.
If you have any questions, please email me at shawn@smrstrategic.com.
