LUTZ BUSINESS INSIGHTS
Back to School on Education Planning
NICK HALL, INVESTMENT ADVISER
It has been well publicized in recent years that the cost of college education is at an all-time high and continues to outpace inflation. Unfortunately, the job market for graduates remains thin six years removed from the 2008 recession. Life happens fast, and as parents, post-secondary education planning often seems to get overlooked or neglected. However, developing a plan of attack and taking advantage of different strategies, such as utilizing 529 college savings plans, can go a long way in helping clients achieve the goal of subsidizing all or part of their children or grandchildren’s education.
The College Board tracks trends in college pricing every year, and the figures for the 2013-2014 school year were published in a recent September 2014 Wall Street Journal article. The average total cost (including Tuition and Fees, Room and Board, Books and Supplies, Transportation, and Miscellaneous Expenses) of a 4-year Public In-State education was $22,826 per year and $44,750 per year for a 4-year Private University. This means that families and young adults have the daunting task of funding approximately $90,000 to $180,000 (in today’s dollars) for a four-year college education.
As a somewhat recent college graduate, I can attest that these costs are definitely not static. In my four years at the University of Arizona, tuition for a non-resident increased from $16,281 in the 2007-2008 academic year to $25,410 for the 2010-2011 academic year (a whopping 56%)! The following graph from the Bureau of Labor Statistics shows the alarming rate of increasing educational costs from 1978 to present day, as compared to the CPI (Consumer Price Index) and other costs such as food and medical care:
Recognizing the pressure of saving for higher education can feel like trying to climb a mountain, but the best course of action is developing a sound strategy that fits into your overall financial plan. There are many vehicles that clients can use for education saving such as CDs, Savings Bonds, UTMA/UGMA accounts, Coverdell Education Savings Accounts (Educational IRAs), and 529 plans. We have found that for a majority of our clients, college saving is given the highest priority as it relates to education funding. As such, 529 plans are generally the most advantageous for college saving due to favorable federal and state tax treatment. There may also be favorable estate tax benefits with the use of 529 accounts.
The tax benefits afforded to families who use 529s can’t be understated, as they accounted for an estimated $1.6 Billion in related tax savings in the 2011 fiscal year according to a report by the Government Accountability Office (GAO)! Originally created in 1996, 529 plans were enhanced in 2001 legislation by Congress that permitted all income within the plans to be withdrawn tax-free if used for educational expenses (tuition and fees, room and board, books and supplies, etc.). Contributions (which are made with after-tax money) also have the benefit of growing tax-sheltered. Families are allowed to change designated beneficiaries of a 529 to another family member without any tax consequences. For example, if the oldest child receives a full-ride scholarship or has funds left over after completing college, the balance in the plan can be rolled over to a younger sibling free of taxes. If your child currently has a UTMA, as the custodian you have the ability to roll over these funds into a UTMA 529 plan. Note: The ownership of the UTMA 529 will still move to the minor at the age of majority unlike normal 529 plans, but this move allows for tax-sheltered growth and tax-free qualified distributions.
Another advantage of 529s is that funds may be distributed from one plan and rolled over to a different 529 plan tax-free (which is common for families moving to a different state). There are often added tax benefits to residents of a state who contribute to their own state-held plan. The state of Nebraska allows annual contributions by an individual up to $10,000 to be deducted from his/her Nebraska state income tax return.
Rules, regulations, and manager changes to 529 plans can make it challenging for individuals to stay on top of this information and require investors and advisors to perform ongoing due diligence. As popularity in these investments has grown, there are a greater number of plans with varying numbers of investment options within each plan. Keep in mind that 529 plans have program management fees and state administrative fees, which combined can range from 0.15% to 0.35%. There are also internal fund expenses on top of the management and state administrative fees. For instance, the Nebraska Educational Savings Trust Plan (NEST) charges a combined 0.30% for these two fees; however, Nebraska’s plan does include many low-cost index funds and ETFs that provide great diversification at very low costs from investment managers such as Vanguard, State Street, and iShares. Regardless, it is important that people understand how much a 529 plan charges in both program fees and internal fund expenses. This awareness remains critical to avoid excessive fees that create a significant investment headwind which a plan then has to overcome in order to match the performance of corresponding non-529 mutual funds. High fees can also erode any tax benefit that may have been derived from the 529 investments.
Although Congress’ original intention of 529 plans was to help the average family save for college, new rules and legislations concerning these plans have turned them into a very valuable estate planning tool. Current IRS legislation permits individuals to contribute up to $14,000 per year to a beneficiary in a 529 account. Another attractive characteristic is the forward gifting provision, which also allows individuals the ability to make a single $70,000 contribution, or $140,000 per couple, in one year that carries forward for a five year period. The five-year carry forward contributions could then be repeated five years later if deemed appropriate (contributions are capped at $360,000 per beneficiary for the state of Nebraska). These provisions make 529 plans very attractive to parents or grandparents who are looking to reduce their taxable estate. 529 plans are the only option that allows contributing parties to do that and still be in control of the assets (unlike an investment like a UTMA/UGMA in which the assets become the property of the beneficiary at age of majority). It should also be noted that 529 contributions do not apply to the lifetime gift tax exemption (currently $5.34 million per individual in 2014). The icing on the cake is that parents or grandparents also fund a child’s education in the process.
Maintaining control of 529 assets offers great flexibility for owners of the plan, and should the funds be needed unexpectedly, they are not tied up in a trust or other limiting vehicle. In the event funds are needed for a non-qualified withdrawal, the penalty is not that egregious. Owners pay a 10% penalty on the earnings and federal/state income taxes on the gains only. The principal can be removed free of penalty or tax because it was contributed on an after-tax basis. For example, if Sam and Sally Smith contributed $50,000 to their daughter’s 529 and the plan now has a balance of $60,000 due to appreciation, they would pay a $1,000 penalty (10% of $10,000) plus Federal and State taxes on the $10,000 gain. In the event a child receives a scholarship, the 10% penalty can be avoided on non-qualified withdrawals up to the full amount of the scholarship. The favorable tax treatment can offset some of the pain of having to potentially liquidate any portion of a 529 account for non-qualified expenses.
At the end of the day, parents and grandparents need to first ask the question, “How much do we want to fund of a child’s or grandchild’s college education?” Answering this question allows families to develop a budgeting strategy that fits into the overall financial plan and increases the likelihood of successfully meeting their goals.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.
ABOUT THE AUTHOR
NICK HALL, CFP® + INVESTMENT ADVISER
Nick Hall is an Investment Adviser at Lutz Financial. With 10+ years of relevant experience, he specializes in creating thorough, adaptive financial plans and investment management strategies for high net-worth families. He lives in Omaha, NE, with his wife Kiley, and daughter Amelia.
AREAS OF FOCUS
- Comprehensive Financial Planning
- Investment Advisory Services
- Retirement Planning
- Income Tax Planning
- Social Security and Medicare Planning
- Investment Project Research
- High Net Worth Families
AFFILIATIONS AND CREDENTIALS
- Financial Planning Association, Member
- CERTIFIED FINANCIAL PLANNER™
- BSBA in Finance and Business Management, Eller College of Management - University of Arizona, Tuscon, AZ
- Mount Michael Benedictine, Alumni Board President
- Lutz Gives Back, Committee member
- United Way, Volunteer
- Salvation Army, Volunteer
- Omaha Home For Boys, Volunteer
- Being Mindful of the Social Security Tax Torpedo & Medicare Surcharges
- Qualified Charitable Donations: Using IRAs as a Charitable Piggy Bank for Investors
- New Tax Legislation and Individual Financial Planning Strategies
- The Ins and Outs of Health Savings Accounts (HSAs)
- Sorting Through the Medicare Alphabet Soup
- Is it Time to "Beary" This Bull Market?
- Does a Roth IRA Conversion Make Sense for You?
- Clinton vs Trump: An Impartial Look Into the Tax Plans of Each Candidate
- Tax Deferral: A Very Powerful Financial Planning Tool
- Volatile Markets Can Lead to a Potential Harvest
- Back to School Education Planning
- Taking Social Security Benefits Early or Late: The Great Debate?
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