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What Can I Do to Save For College?

July 12, 2021

Over the last couple of months, you’ve listened to me go on about the increasing cost of college and some things you can do to help mitigate those costs.  This month I’m going to work right in my wheelhouse and show you a few ways you can be proactive and save for college.  I’ll lay out a couple of the most popular ways to save for college along with some of their positives and negatives.

UGMA/UTMA

This has been the go-to account type for a lot of people in the past.  These accounts allow you to open an account for a minor and still control it for a while. Over the years I’ve seen a lot of grandparents use this vehicle.  You can open a savings account or investment account for your kids (or any minor you want) that you control until they reach the age of majority in your state, which is 18 in Missouri.

Pros

  • There are no limitations on what you can purchase in one of these accounts.  This can include cash, stocks, bonds, fine art, real estate, and even intellectual property.
  • It can be used for anything that benefits the child, not just college. That’s a pretty lose definition which means you can use a UGMA/UTMA account to buy your kid almost anything at any time before their 18th birthday as long as it benefits them.
  • Anyone can contribute up to $15,000, $30,000 for a married couple, per child each year.

Cons

  • A UGMA/UTMA account belongs to the child not you. This means if you put $50,000 into that account your child gets control of that money on their 18th  I went to school with a girl that had a $25,000 UTMA account from her grandmother.  Let’s just say that money didn’t go towards her college expenses, but she sure did drive a nice car.
  • The money gets taxed every year. This can be at either the custodian’s rate or a “kiddie tax rate” depending on the amount of income the child has.
  • It counts as your child’s assets when it comes to financial aid. FAFSA counts 50% of the account value in aid calculations vs 5.64% for parental assets.

529 Plans

This is the one most people have heard of, it also happens to be the foundation of my education savings strategy for my kids.  The name 529 comes from the tax code that was used to create these accounts.  They are extremely flexible, portable, and the most tax advantaged way you can save for education.  I say education because they can be used for more than just college.

Pros

  • Withdrawals from this account are tax free so long as the funds are used for qualified expenses such as tuition, room, and board.
  • You are able to use 529 funds for college, tech schools, beauty schools, foreign schools (think Oxford) as long as they accept US financial aid, and even k through 12 private school now.
  • If you have funds leftover when your oldest graduates you can change the beneficiary to another of your kids, your grandkids when you have them, yourself and go back to grad school, or even a niece or nephew.
  • You can change the ownership if needed. If your parents opened a 529 plan for your child, they can make you the owner with no tax consequences.
  • The money belongs to you, so your kids don’t get a pile of cash when they turn 18.
  • It is counted as parental assets for financial aid so they only count 5.64% of the account value.
  • Anyone can contribute to a 529 you own or open their own with your child as the beneficiary.
  • Anyone can contribute up to $15,000, $30,000 for a married couple, each year. You are also able to make what is called a 5-year forwarding contribution. This allows you to make 5-years of contributions in the same year.  There are some things to be aware of if you are going to do this, so you should consult a Financial Advisor first.
  • There is no federal tax deduction, but Missouri allows you to deduct up to $8,000, $16,000 for a married couple, of your contributions from income taxes.
  • You can use money from a 529 plan to pay some of the costs of living off campus. The short answer is if it costs $5,000 per semester for on campus housing you can use that amount for off campus rent.

Cons

  • You have to use the money for qualified education-related expenses. If you take a non-qualified withdrawal, you will owe income tax and a 10% penalty on the gains over your contribution.  This means no new golf clubs for dad to practice with your son even if he is on the golf team.
  • This one is tricky, it’s great if your children get scholarships but it doesn’t allow you to access 529 assets for free. If your child gets a scholarship worth $20,000 a year you can withdrawal $20,000 a year from a 529 plan without incurring the 10% penalty, but you still have to pay income tax on the gains over your contributions. This also applies to military academies.
  • This one is a little morbid but can be a big one. If some one makes a 5-year forwarding contribution and dies 3 years later, 2 years’ worth of the contribution has to go back into their estate.  I haven’t personally run across that situation yet but it’s good to know.

No matter what path you choose to walk down for your college savings, I hope I at least gave you some talking points for the next time you meet with your advisors.  Feel free to reach out if you have any questions before next month when we’ll start to dip our toes in the water of financial planning.

Helping you with preparation,

Jon-Paul Brown

 

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