One conversation I often encounter with clients is their feeling that they are behind on college savings. If you have these same thoughts, you’re not alone. These conversations usually go in one of two directions—clients either think they haven’t saved enough money, or they haven’t started saving for college yet. Do not fret if you have the same feelings. There are several things you can do to get on track. Here are five simple steps you can take now to stop those uncomfortable feelings:
For your long-term financial health, as well as your child’s, saving, rather than borrowing, is preferable. Money that’s been set aside in a 529 plan or other savings account has the potential to earn interest or gains. Taking loans, on the other hand, requires you to pay interest, sometimes well into future years. Even increasing your savings by a small amount might substantially increase your child’s college nest egg due to the power of compounding interest.
Tax-advantaged accounts — where taxes can be deferred or even eliminated — can greatly help you protect any gains. There are multiple different vehicles to choose from, depending on your circumstances. After considering the option with your financial advisor, choose what’s most practical for you depending on your situation.
One strategy I use most often with my clients is a 529 college savings plan. When you save for your child’s college a 529 plan, your investments grow tax-free and, depending on where you live, you might be entitled to a state tax break. Whether a state tax deduction and/or application fee savings are available depends on your state of residence. Additionally, withdrawals from the account made for qualified higher education purposes may be tax free. Rules around 529 plans allow for large annual contributions (more on that below), so parents who believe they are behind in college savings might be able to increase their savings quickly. Before investing in a 529 plan, you should research the particular plan and its fees and expenses. You should also consider that certain states offer tax benefits and fee savings to in-state residents. For tax advice, it’s always best to speak with your accountant or tax professional. And remember, nonqualifying distribution earnings (withdrawals not spent on higher education) are taxable and subject to a 10 percent tax penalty.
Another option is a Coverdell Education Savings Account. Coverdell accounts have many similarities to 529 plans but also some key differences. Amounts deposited in a Coverdell account grow tax-deferred and distributions can be tax-free if they’re used to pay for educational expenses. Unlike 529 plans, Coverdell accounts can be used not only for college, but for Kindergarten through grade 12 expenses—and beyond—as well. However, these types of accounts are not appropriate for high earners because there are income eligibility limits. A parent’s ability to contribute is phased out as your adjusted gross income increases to $110,000 for individuals, and $220,000 for married couples filing jointly. Contributions limits are also very low, just $2,000 a year per beneficiary.
One strategy I discuss with clients is establishing automatic transfers from your bank accounts or payroll deductions. Creating this planned behavior has shown to increase the probability of success in reaching your college savings goal.
When grandparents, aunt and uncles, and friends ask what your child would want as birthday gift, suggest the gift of college through contributions to a 529 plan. Over the years it’s become common for the special people in a children’s life to make contributions to a 529 plan.
I’ve seen more and more family and friends embracing this thoughtful option. I’ve found grandparents are especially interested in leaving a legacy to their grandchildren through 529 accounts. An interesting feature of 529 plans is that family members can accelerate five years’ worth of contributions into one gift of up to $75,000 per person and $150,000 for married couples without incurring any gift-tax consequences. This could be a huge kickstart towards college savings.
In the last months of 2018, we witnessed some volatile markets. Imagine if your child’s 529 plans were invested incorrectly right at the time you needed to start making withdrawals to pay for college. That is why it is important to monitor your investments with a financial advisor. As your child’s college years draw nearer, it’s often wise to focus on more conservative investments to protect your college savings potential market downturn. Resist the urge to try to earn big returns in a short period of time. Don’t be overly aggressive in your asset allocation. Speak with your financial advisor about the ways to protect or limit your accounts at the worst times.
Catching up on college savings might feel like an unattainable goal, but starting to save or increase savings now could lead to more secure college funding when the time comes.
Anthony N. Corrao is president, wealth management and director of corporate education at Manhattan Ridge Advisors. For more than 25 years he has helped families towards their financial goals by developing financial, educational, and retirement planning strategies.
The information is intended for informational purposes only, and is not intended to be a substitute for specific tax, legal or investment advice. Securities offered through First Allied Securities Inc., A Registered Broker Dealer. Member FINRA/SIPC. Advisory services offered through First Allied Advisory Services, A Registered Investment Adviser.