Save Smart for School with a Plan

Copyright: <a href='https://www.123rf.com/profile_gstockstudio'>gstockstudio / 123RF Stock Photo</a>Now that it’s May, graduation time is right around the corner. Many kids (and their parents) are getting ready for the next stage of their lives, whether that brings them to college, the military, or somewhere else. This time of year, I often see the anxiety in parents of younger kids, as they realize that they’re poorly prepared for the financial reality of sending their future seniors off to a good school.

I hope you’re not in that boat, but if you feel unprepared for your child’s graduation – whether it’s next month or years from now – take some solace in the fact that you’re not alone. A recent survey from Student Loan Hero found 44% of parents feel guilty that they aren’t saving enough for college for their kids.

The parental guilt over student loan debt is understandable. The cost of higher education is higher than ever. The College Board reports that the average annual cost of tuition and fees at public four-year schools last year was $9,970, and for private four-year schools, $34,740. The College Board also reports that full-time students covered about 60% of their tuition and fees in grant aid and tax benefits, or about $5,830 and $20,210 per year, respectively.

Almost 1 in 4 parents – 23% in total – aim to save $10,000-$20,000 by the time their kids are ready for college. In today’s market, that’s not enough to cover the difference between what that 60% receive in grant aid or tax benefits and the cost of tuition at a four-year public university (not to mention the cost of room and board). That means drawing on savings or taking out loans to make up the difference.

But surprisingly, most of the parents polled (74%) were using a plain old savings account to reach their savings goal.

High-interest savings accounts are yielding only about 1.5-1.6% interest right now. Let’s say you’re able to sock $200 away every month for the next 15 years. At 1.6%, you’ll end up with about $41,000 by the time you’re done. That sounds great until you run the numbers. You’ll have earned a scant $4,727.86 on $36,000 invested. That’s significantly less than the growth you would hope to have seen on an index fund or other investment with growth potential.

Folks, unless you save a lot, you’re probably not going to get where you need to be by stashing your money away in a traditional savings account. But there are other options to help you make your money work much smarter for you.

One method to save for school that offers some tax advantages is a 529 plan. 529 plans offer different investment options with potentially higher rates of return than savings accounts. They are special tax-advantaged savings plans, sponsored by states, state agencies or educational institutions, that encourage parents and others to save for kids’ college expenses. Contributions to a 529 plan aren’t tax-deductible (for federal income tax purposes), but earnings grow tax-free if the funds are used to pay for qualified educational expenses at colleges, universities or certain post-secondary training institutions nationwide. And beginning in 2018, 529 plan funds can be used to pay for up to $10,000 in tuition expenses for private, public or religious elementary and secondary schools, as well. So, a 529 plan is not just for higher education – it’s a smart way to save if your child has tuition expenses beginning as early as elementary school.

Although many parents take advantage of 529 plans to save for their kids’ education, many do not. When asked why, parents voiced a lot of confusion about how 529 plans work, according to a recent report from Fidelity.

For example, some parents think that the money can only be used for tuition and fees, which is incorrect. If being used for college, the money can be spent on books, room and board (including apartment expenses for students living off-campus enrolled at least half-time) and required supplies and equipment. That includes computers, tablets, and Internet access, according to the IRS.

Others believe that if the money isn’t used for education, it’s lost. Not true. Any non-qualified withdrawals from a 529 plan are subject to income tax and a 10% penalty on the earnings. The penalty is similar to the penalty for taking a distribution from a tax-deferred retirement savings plan (like a 401(k)) before age 59 ½ – obviously not something you want to do if you can help it, but you won’t “lose” your money.

Rather than withdraw the money if it is not needed for the intended beneficiary, the beneficiary can be changed (provided it stays in the family – which includes siblings, descendants, parents and cousins). The rules can get complicated if beneficiaries are changed, so consult your financial specialist for the best course of action if this applies to you.

Another common belief is that once a 529 plan is opened, it cannot be moved or changed. That is also incorrect. Generally, the funds in a 529 plan can be rolled over to a different 529 plan. Additionally, the investments within a plan can be changed twice per calendar year, or when beneficiaries are changed.

Some parents mistakenly think that if they open a 529 plan, it will hurt their child’s future chances of receiving financial aid. But the assets in a 529 savings plan owned by a parent are factored into the “Expected Family Contribution” (EFC) of the federal financial aid formula at a maximum rate of 5.64%. That’s compared to the 20% rate the Feds use to assess your student’s own investment assets in a UGMA or UTMA custodial account.

So, if you’ve saved $10,000 in a 529 plan for your student, only $564 of that would be included to determine financial aid eligibility, compared to $2,000 in a UGMA or UTMA account.

One of the Massachusetts sponsored 529 plans, offered through MEFA – the Massachusetts Educational Financing Authority – allows participants to prepay for tuition and fees at Massachusetts state colleges and universities, locking in today’s rates. It’s called the U.Plan.

With the U.Plan, if your child decides to go to a non-participating school – such as a state school located outside Massachusetts, or a private college or university – you’ll have your investment plus interest returned to you without any penalty (though you won’t be able to lock in yesteryear’s tuition rates at that other school).

If a Massachusetts resident participates in either the U.Plan or invests in MEFA’s 529 College investment plan, the U.Fund College Investing Plan, there’s a nice state tax benefit, too. Massachusetts residents can deduct up to $1,000 in contributions from their state income tax ($2,000 for couples filing jointly) – that was new last year and runs through the 2021 tax year at this point.

Obviously the longer you have time to save, the greater the benefit you will see with any savings plan – because savings is the key here, with growth and interest compounded over time. But even if your child is going to start college soon, is in college, or is thinking about graduate school, it’s never too late to save what you can.

Be vigilant and stay alert, because you deserve more.

Have a great week!

Jeff Cutter, CPA/PFS is President at Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@cutterfinancialgroup.com.

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