The 529 Plan Series – Part I: Plan basics

At Merriman, we often help our clients plan for more than just retirement. One topic that commonly comes up is saving for college. My colleague, Lowell Lombardini Parker, wrote about the various college savings options in an earlier post, and this three-part series will focus specifically on the 529 plans highlighted in his article. Part I will review 529 plan basics; Part II will evaluate Washington’s 529 prepaid tuition plan, known as the GET; and Part III will take a look at the best 529 savings plan we know – the West Virginia Smart529 Select. (more…)

Five easy strategies to save on college costs

High school seniors are now in the process of getting acceptance letters to colleges.

When the thick envelope comes, there will be well-deserved joy, possibly followed by the dismaying thought on how to actually pay for those four expensive years.

Hopefully, parents will have done some advanced planning and saving for this major event. There are various strategies which can substantially ease the financial burden of higher education, some of which should be started many years before high school.

Background

Before we discuss strategies, let’s review some key terms, as they say in school.

There are two major financial aid forms which could be completed. The first is FAFSA, the Free Application for Federal Student Aid. This has to be submitted to be considered for any federal financial aid. It can be completed as early as January of the child’s senior year in high school. FAFSA assumes that 5.64% of parental assets can be used to fund annual college expenses, while the assessed rate on the children’s assets is a much higher 20%.

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College savings options

In today’s competitive job market, saving for your child’s higher education is as important as ever. Although there are not an overwhelming number of savings choices, the subtleties between them are paramount. Below you will find what we at Merriman feel are the most important distinguishing characteristics between 529 plans, Coverdell ESA’s and UGMA/UTMA accounts.

529 PlanCoverdell Education Savings Account (ESA)Uniform Gift/Transfer to Minor Account (UGMA/UTMA)
Investment options availableThere are two types of 529 plans: 1) 529 savings plans, where the mutual fund investment choices are dictated by state run allocation programs, 2) 529 prepaid plans, which allow you to purchase tuition credits at prevailing rates. Investment options include individual stocks, CD's, or mutual funds. Precious metals, collectibles, partnerships in private business and direct ownership in real estae are not permitted.These accounts allow for stock, bond, and mutual fund investments. However, stock options and buying on margin are not allowed.
Contribution limitsYou can currently contribute $13,000 per year. As an alternative, you can contribute $65,000 (five times the annual gift tax exclusion) without incurring gift taxes, but then cannot contribute for the next four years.You can contribute a maximum of $2,000 annually. For 2011, contributions above $13,000 per year ($26,000 for married couples) are subject to gift tax.
Donor income restrictionsThere are no donor income restrictions.Donor income restrictions apply.There are no donor income restrictions.
Tax implicationsAssets grow tax-free and withdrawals are tax-free if used for qualified education expenses.

Certain states offer tax incentives for investing in 529 plans.
Contributions are not tax-deductible, but the account grows tax-free and withdrawals are tax-free if used for qualified education expenses.

Both the Hope and Lifetime Learning tax credits are allowed in the same year as an ESA withdrawal is made.
Contributions are not tax-deductible and they do not receive the tax benefits associated with 529 plans and ESA's.
Restrictions on use of fundsWithdrawals are only tax-free when used for qualified education expenses.

There is no age limit for investment disbursements.
The assets can be used for eligible expenses from kindergarten through graduate school.There is no requirement to use the funds for qualified education expenses.

When the beneficiary reaches the age of majority (usually 21, but could be 18 depending on the state), there are no restrictions on the use of withdrawals.
Who owns the funds?The account owner retains complete control of the assets and may change the beneficiary to an eligible family member of the original beneficiary. The account owner retains complete control of the assets and may change the beneficiary to an eligible family member of the original beneficiaryAssets are treated as belonging to the beneficiary, and will impact their ability to receive financial aid.

Rising college debt levels

This article in The New York Times (Lewin, Tamar, “Burden of College Loans on Graduates Grows”, April 12, 2011) speaks about the growing total level of college debt, which is a function of increasing college costs, increasing numbers of students going to college and the increasing numbers of those students who need to borrow to attend school.

The article goes on to state that two-thirds of those who received bachelor degrees graduated with debt in 2008, compared with less than half in 1993. In 2010, the average loan amount for those graduates finishing college with debt was $24,000.

Attending college is great for its own sake, and also leads to substantially higher lifetime earnings and lower unemployment. However, both parents and students should consider the incremental costs and benefits of attending, for example, an expensive out-of-state private university instead of an in-state public university. Both might give the student a fine education, with good prospects for future potential graduate schools and/or jobs.

The private school might have more prestige.  The question is whether this is a sufficient inducement to incur large amounts of debt which could negatively impact the retirement plans of the parents or the future lifestyle of the student. There is no right answer to this, but it is certainly something our clients can discuss with their financial advisors.