Paying for college requires a solid plan. Assuming you have children who may one day go to college, are you prepared? Is paying for college for your children your obligation or a gift you would like to give them? Do you want to help them avoid student loan debt? Are you doing enough now?
As you have likely already discovered, college costs are frighteningly high. They seem to be increasing further without an end in sight. At the same time, a college education seems to be a requirement for even the most basic white-collar entry-level job.
Paying for college 15 years from now will require a staggering sum. If you haven’t tried to estimate how much will be needed for your children’s education, you may start with an online calculator.
A 529 account probably is the best option for high-income professionals. We will explore the 529 option in the most detail, but also discuss some alternatives.
You can set up a 529 college savings account for your child as soon as they have a social security number. The earlier you contribute, the more time there is for the money to grow through the miracle of compounding. The funds will grow tax-free and can later be withdrawn tax-free for educational expenses. 529 accounts can also now be used for K-12 private school costs.
You can make these contributions through a mutual fund company. If you already have investment accounts, you may choose to use that same company. There are many options of what to invest in as well. Many funds have a fixed asset allocation choice for you to choose. You will need to read the details from your fund company. If you already set up a 529 fund do you know how it is invested? If it is a fixed allocation now might be a time to make an adjustment. It would be easier if it would “auto-adjust” over time. That approach is available and is called a “glide path.”
Glide Path Approach
Vanguard now uses a glide path approach to their 529 college savings plans. This automatically creates a less aggressive asset allocation as the student gets closer to college.
The glide path is easier and more effective than continually tinkering with the allocation. You do have to choose a path at the outset. There is a conservative, moderate, or aggressive route.
Essentially the determinant is the ratio of stocks to bonds. The farther away college is (the younger your child) the more the money will be invested in stocks as opposed to bonds. As they advance into the teenage years the allocation shifts more to bonds. The aggressive path has more equities than the moderate path. The moderate path has more equity investment than the conservative route. If you truly have no idea how to choose, go with the “moderate” choice.
There may be more bond investment than you might expect when comparing to your retirement accounts. That is because the time horizon to paying for college is much shorter than for retirement.
To give you an idea, I selected some years and allocations from the moderate age-based option.
Many Benefits of 529 Accounts
The glide path is a great approach, but not the only way. The main thing is to invest. We can quibble over a percent here or there, but the key factor is the time in the market. If you have children and don’t have college funds set aside, start looking at investment options. The best benefit from the tax-shelter comes from front-loading the 529 with as much as you can as early as you can.
The glide path will also ensure you are growing those early dollars with equity investing. Lastly, remember if your investment is too successful and you have excess funds, that is not a problem. You can transfer the funds and pay for someone else’s college. You could help a nephew, grandchild, or even yourself by paying for educational expenses.
State Tax Benefit
Many states offer a tax deduction for contributions into that state’s 529 college savings plan. Other states offer something even better – a tax credit. Tax credits are much more valuable than a deduction since it is subtracted from the tax bill you would otherwise owe.
The amounts vary by state. Indiana, for example, allows a 20% per year tax credit on a 5K contribution up to a full $1,000 credit per year. Not bad. If you lived in that state, you would lose out by contributing less than $5,000 per year.
Look up your state and know the details here.
529 Plans: Questions and Answers (Compliments of IRS)
Q. What is a 529 plan?
Answer. A plan operated by a state or educational institution, with tax advantages and potentially other incentives to make it easier to save for college and other post-secondary training for a designated beneficiary, such as a child or grandchild.
Q. What is the main advantage of a typical 529 plan?
A. Earnings are not subject to federal tax and generally not subject to state tax when used for the qualified education expenses of the designated beneficiary, such as tuition, fees, books, as well as room and board. Contributions to a 529 plan, however, are not deductible.
Q. Can anyone set up a 529 plan?
A. Yes. You can set one up and name anyone as a beneficiary — a relative, a friend, even yourself. There are no income restrictions on either you, as the contributor, or the beneficiary. There is also no limit to the number of plans you set up.
Q. Are there contribution limits?
A. Yes. Contributions cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary. If you contribute to a 529 plan, however, be aware that there may be gift tax consequences if your contributions, plus any other gifts, to a particular beneficiary, exceed $15,000 during the year (2018). For information on a special rule that applies to contributions to 529 plans, see the instructions for Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Q. Are there different types of 529 plans?
A. There are two basic types: prepaid tuition plans and savings plans. And each state has its own plan. Each is somewhat unique. States are permitted to offer both types. A qualified education institution can only offer a prepaid tuition type 529 plan.
Q. Am I restricted to my own state’s 529 plan?
A. No. Your state’s 529 plan may offer incentives to win your business. But the market is competitive and you may find another plan you like more. Be sure to compare the various features of different plans.
Q. Who controls the funds in a 529 plan?
A. Whoever purchases the 529 plan is the custodian and controls the funds until they are withdrawn.
Q. Each 529 plan account has one designated beneficiary. What does that mean?
A. A designated beneficiary is usually the student or future student for whom the plan is intended to provide benefits. The beneficiary is generally not limited to attending schools in the state that sponsors their 529 plan. But to be sure, check with a plan before setting up an account.
Q. Can I change the beneficiary of a 529 plan I have set up?
A. Yes. There are no tax consequences if you change the designated beneficiary to another member of the family. Also, any funds distributed from a 529 plan are not taxable if rolled over to another plan for the benefit of the same beneficiary or for the benefit of a member of the beneficiary’s family. So, for example, you can roll funds from the 529 for one of your children into a sibling’s plan without penalty.
Q. What is an eligible educational institution?
A. An eligible educational institution is generally any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education.
Paying for College with 529 Alternatives
Cash Flow It
Most physicians and high-earning professionals have the option of helping their child with expenses out of discretionary income from earnings. Parents are often mid-career and middle-aged at that point. Their earnings may be near peak. If there isn’t much cash to spare, parents could consider cutting back on other expenses or even retirement contributions for a few years to help.
These are often called Coverdell Education Savings Accounts (ESA). Unfortunately, they have income limitations. If you are a medical specialist or even a successful primary care doc you are likely ineligible due to the income limits. If you are working part-time or a resident, you likely will qualify. You can only contribute up to $2,000 per year though, so that isn’t much help.
Uniform Gift to Minors Act (UGMA) is basically a fund that will belong to your child when they turn 18. Since it belongs to them, it may affect their financial aid status. You probably make too much for that to matter anyway. There aren’t really tax advantages to this account. You can contribute up to the allowable annual gift tax amount without adding taxes.
If you are a high-earning and high-saving physician, you likely have more money in your taxable accounts than in your tax-advantaged accounts. Those funds can be used for your child’s educational expenses. There is no limit, but there isn’t a tax benefit either. You will have to pay tax on any capital gains.
This table from Vanguard may help clarify the differences:
This is a lot of what is passed off as “aid.” Loans can be in your name or in your child’s. Either way, they are not a good option. This is available for the struggling middle-class. This should not be your plan as a high-income professional. Set aside the money in one of the vehicles discussed. Encourage your child to get scholarships and to work. Teach them how to live frugally. Cash flow the rest. There is a whole generation of unemployed or under-employed college graduates who are starting life with the student loan monkey on their back. That is not a good way to start a career. With a little planning, you can prevent your child from being one of them.
The U.S. government encourages its citizens to become educated. There are many ways those programs could help you. Look into military service, TEACH grants, Public Service Loan Forgiveness, the G.I. Bill, AmeriCorps, and the National Health Service Corps.
Will your child need to physically go to a college? Technically, that is no longer required. A college education can now be obtained online. It does take a good internet connection and a boatload of discipline, but it can be done. And for a lot less than a traditional college education. You can explore some of those options here.
Community Colleges used to be called Junior College. They are two-year schools that have one and two-year programs for technical training or liberal arts. They still have not overcome their inferiority stigma, but don’t overlook this option. I started my postsecondary education at a Community College. I learned more there than anywhere else. The professors were dedicated teachers and took the time to help struggling students (like me). After receiving my Associate in Science (A.S.) in Liberal Arts, I transferred all of my credits to my state’s most competitive public university. It was great to be able to start as a junior. Two years later I graduated with my B.A. which took my classmates four years and a lot more money to obtain.
Will your child be encouraged to work and save? This is optional, but I think they value the education more if they earned some of the money that paid for it. I worked in college. It made me feel productive and valuable. Working also forced me to learn invaluable time management skills.
Scholarships & Grants
Too many high-income professionals pass over this area thinking they wouldn’t be eligible. There are thousands of grants and scholarships out there. Many are not based on financial need. Help your child to apply for everyone for which they could be eligible.
Some schools and states are beginning to waive tuition, especially for community colleges. Even some graduate schools are offering free tuition (e.g. NYU School of Medicine). Many elite schools like MIT have placed all of their content online. Add the word MOOC to your vocabulary. An enterprising student can obtain an education at minimal or no cost. Scott Young got all of the knowledge of a four-year MIT degree in just one year online. Laurie Pickard writes about how to get an MBA at little or no cost.
Start a Business
Although the very idea of not going to college may be heresy in over-educated families, it is worth considering. Many of the richest people in the world avoided college or dropped out (think Bill Gates or Mark Zuckerberg). If your student is eager to build a business, travel the world, serve a mission, maybe that is the right choice. What if we used our resources, skills, and connections to help the next generation build creative businesses? Is that so much worse than sitting in Latin class, mastering beer pong, or playing hacky sack on the quad?
Well, what do you think? Will you encourage your children to go to college or grad school? How much will you help them financially? Do you have a solid plan in place to ensure you will be able to pay for college?