WHY A FINANCIAL PLAN? STEP FOUR: COLLEGE SAVINGS
In the event one of your goals is to save money for your child or children’s college tuition, this part of your financial plan may be of assistance. I have heard it said that when discussing college savings, you will never be able to save enough. In many cases this rings true, many of us will never be able to anticipate the true total cost of college. And it is no wonder, since it is a very evasive moving target. When trying to calculate the increases in tuition relative to an average inflation rate of 3%, college costs may have increases of 6, 7, or even 10%. This industry has the most outrageous inflation rate.
DIFFERENT VEHICLES TO COLLEGE SAVINGS
Do not despair; we should still accumulate what we can. There are a number of vehicles to fund for college expenses: 529 college savings plan, Coverdell Education Savings account, Uniform Gift to Minors Act account and if all else fails, the parent’s investment account. Each has distinct differences.
529 College Savings Plan
The 529 plan provides the most control to the parent. If the child decides not to attend college the parent does not have to turn the funds over to the child. The parent may change the beneficiary or cash out the account. The funds grow tax free and are subject to tax only in the event a distribution is made that is not for higher education expenses. The funds will then become taxed and subject to a 10% penalty. The 529 plan allows up to a one time $250,000 contribution or any increment below that amount in multiple contributions. The only short comings are higher investment expenses and fewer investment choices.
Coverdell Education Savings Account
The Coverdell IRA allows $2,000 per year contribution. The Coverdell IRA beneficiary can take control of the funds upon age 18. The funds grow tax free. The parent will lose control of the funds at that time. The parent can change the beneficiary of the IRA like the 529 plan. The major short comings of the Coverdell IRA is the low contribution limit. $2,000 per year may not be enough. And depending upon the custodian of the IRA the investments choices are much broader.
Uniform Gift to Minors Act Account
The Uniform Gift to Minors Act account is what we used prior to the 529 plan and the Coverdell IRA. It can earn tax free up to the first $850.00. Earnings from $850 to $1,700 are taxed at the parent’s rate. Once the child reaches age 18 the earnings are taxed at the child’s rate. The UGMA has almost unlimited investment possibilities. There are tables and brochures that are available that detail the differences side by side.
Some advisors offer life insurance as a vehicle for college expenses. The reality is you will not be able to fund enough money in the cash value of a whole life policy, universal life nor variable life policy. The life insurance is good to fund college in the event a parent dies too soon and will not be available to assist in saving for college. The cash value will help, but much of the initial premium payments go to the insurance expenses and commissions.
My children have a life insurance policy on their lives that has a fair amount of cash value. But the purpose was to insure them at a very low price, while saving them the expense of purchasing later in life and possibly at the risk of becoming uninsurable for some odd health concern. The cash value will be available for use towards college tuition, but I anticipate it may cover only a couple of semesters when the time comes.
CALCULATIONS TO COLLEGE
The main things to consider in calculating the necessary savings for college are:
- Your child’s current age
- Assumed annual college cost
- An inflation factor
- Rate of return factor
- Number of years for college you wish to fund
I found a fairly good web site that details the current cost of college, www.CollegeBoard.com. There is an article titled “Sticker Price vs. Affordability”. This may give you a better idea as to what to expect in tuition price and inflation rates to anticipate.
Bear in mind, your child may want to go to a trade school instead of college. Your savings goal may be reduced. Additionally, many people will not be able to save enough to cover the entire cost and the child may have to work during college. This is not an altogether bad idea, and could very possibly focus them on more college and less play. A talk show host made the statement “we should not take the risk of poverty away from our children.” Meaning we should not give everything to them and they should work for what they receive at the risk of losing it.