June 24

College Financing 101

Congratulations! You are a new mother or father! You are now embarking on the lifelong journey of parenting.

It can be overwhelming to think about saving for your newborn's higher education, even though it is an important investment that should be considered and planned for early on. According to the US Department of Education, the average cost of a year at public school is $15,100 and $32,900 for private institutions. These costs of tuition are growing faster than both inflation and wage growth. This means that by 2030, annual public tuition will be $44,047. The total cost for a four-year degree will be more than $205,000.

You may be asking yourself: what options do I have in regard to investment accounts that best suit saving for higher education? There are two types of tax-advantaged college savings plans designed to help parents finance education: 529 Plans and Education Savings Accounts (also known as ESAs or Coverdell accounts). In addition to these tax-advantaged savings plans, another option is to open a UGMA/UTMA account. A Uniform Gift/Transfer to Minors account differs from ESAs and 529 plans in that they are not designed solely for education. The descriptions below further explain the benefits and restrictions of each account.

1) 529 Plans

            A 529 plan is a state-sponsored, tax-advantaged way to save and invest for a child's future educational endeavours. The plan grows on a tax-deferred basis, and the money—including any gains and investment income—can be withdrawn tax-free assuming its used for educational purposes. Withdraws from the 529 account can be used to pay for any qualified educational expenses (tuition, room/board, books, etc.) at any eligible U.S post-secondary institutions.

Each state has their own 529 plan and you may choose to use any states plan, even if you do not reside in that state. Some of the key characteristics of a 529 plan are that anyone can open an account, contribute to the account, and can contribute regardless of their income. In addition, beginning in 2018, funds withdrawn from 529 plans may also be used at K-12 institutions.

Another advantage of the 529 plan is it has higher contribution limits than other college savings accounts, up to $300,000 per beneficiary, and the account holder remains in control. Furthermore, 529 college savings accounts offer generous benefits for anyone looking to save for educational expenses on a relatively unrestricted basis.

2) Education Saving Accounts (ESA's or Coverdell)

            While 529 accounts and Education Saving Accounts (ESA) offer very similar benefits, there are some key differences. The ESA allows for withdrawals for qualified elementary and secondary expenses, as well as for postsecondary school. The tax-deferred growth and tax-free withdrawals as stated in the 529 plan description are the same as ESA's, although ESA's have a few more qualifications and restrictions. Some of these restrictions include income limits, contribution limits, and liquidation constraints.

Income limits in Education Savings Accounts are stated as couples with adjusted gross income of less than $220,000 are eligible to open an account (for an individual it is $110,000). In addition, the income limit for merely making a contribution to the ESA is $190,000 for married couples or $95,000 for individuals. Contribution limits as defined by ESA's state that contributions are limited to a maximum of $2000 per year until the beneficiary's 18th birthday.

Finally, ESA's call for liquidation of the remaining balance once the beneficiary turns 30. However, the beneficiary may choose to roll over the balance for another family member to use, thereby avoiding taxes and penalty. This benefits allow a family to accumulate savings and roll them over for their younger children entering college.

3) Uniform Gift/Transfer to Minor (UGMA/UTMA)

            A UGMA/UTMA differs from the two accounts listed above in that fact that it is not solely designated for educational expenses. The account is in the child's name but it usually controlled by a custodian. The custodian is usually responsible for managing the account until the beneficiary turns 21 (18 for UGMA). Once the beneficiary takes control of the assets, he/she is free to use them as they choose. This means that they are able to use the assets for educational expenses, but they are also able to use the funds for anything else.

One of the disadvantages of using this type of account is that the ownership cannot be changed or rolled over such as in an ESA. Furthermore, a UGMA/UTMA can be used to save for a child's educational expenses, although it does not offer the tax benefits or the ability to roll the funds over for future educational expenses.

            529s, Education Savings Accounts, and UGMA/UTMA accounts all offer the account holder and the beneficiary ways to save for future educational expenses. It is imperative to review your financial situation with a financial advisor, such as Chicago Partners, to determine which type of savings account is right for you. Your income, age, and expected future capital needs all affect which type of account suits you best. Chicago Partners would welcome the opportunity to assist you in making the best decision to ultimately reach your educational savings goals. Contact us today to get started!