According to a recent report compiled by the College Board and posted on the website www.savingforcollege.com, the average cost for four years of (in-state) tuition and fees at a public University is approximately $33,500, and costs just go up from there if you select an out-of-state public university or private college. In 18 years, based on the current rate of inflation for education, the $33,500 figure could easily be between $90,000 and $100,000.
There are many ways to save for college; one of the most flexible is the 529 plan, established by section 529 of the Internal Revenue Code. Although these are authorized by the Federal Government, they are established on the state level. All 50 states have adopted at least one qualified tuition plan.
There are several benefits to investing in a 529 plan that make it a particularly attractive choice for college savings. Although there is no federal tax deduction on contributions, the earnings grow tax deferred and the distributions, if used for qualified post secondary school expenses (tuition, room, board, books, supplies, etc.) are federal income tax free. There may be a state tax benefit if you invest in your state’s plan. Contribution limits are much higher than other options (up to $130,000 per year for a married couple can be given to each beneficiary without gift tax ramifications) and there is no income limits for participation.
This makes the 529 a potentially powerful estate planning tool. If congress does nothing, the estate tax exemption limit drops back down to $1 million. So, grandma and grandpa can help pay for the grandchildren’s education and reduce the size of their estate potentially decreasing or eliminating wealth transfer taxes on their estate. Lastly, the beneficiary on a 529 plan can be changed from one family member to another. So, if John Smith Jr. doesn’t use all the money in the 529 plan established for him, his sister, Jane Smith can be named the new beneficiary. And, if you the donor successfully get all the kids and grandkids through school and out of the house, Mrs. Smith can use the remaining balance to go back and get her masters degree or go to culinary school! The worse case scenario is, nobody in the family can use the money for education and the money is withdrawn for another reason, the earnings will be taxed and may be subject to 10% penalty. But, there will never be a federal income tax or IRS penalty to get out the original amount invested. State laws regarding taxes and penalties can vary from state to state, however, and may apply; you should always check with your tax professional before making this type of withdrawal.
Please keep these three things in mind. First, estate planning is complicated. Before doing anything, consult an attorney. The same can be said of financial aide rules, and regulations. So, be sure before making any investments for college, to determine with the help of a professional the most efficient way to position your income and assets to receive the maximum benefit available to your child. Lastly, there are many ways to finance college and very few to fund a successful retirement. So, as the cabin suddenly loses pressure and the oxygen masks fall from the ceiling, make sure yours is securely on before you help you child with theirs… if you catch my meaning.
(Editor’s Note: Chad Winn is a financial advisor and chartered retirement counselor for Wells Fargos Advisors, LLC.)