LUTZ BUSINESS INSIGHTS
planning for college pragmatically
justin vossen, cfp®, napfa + Investment adviser, principal
Many parents have a goal of encouraging their kids to go to college. The dream of higher education is often a large driver in most parental decisions for their children. Financially it makes sense; the average college graduate with a bachelor’s degree makes $71,155, according to the U.S. Census Bureau for workers 18- and older in 2018. This is 83% higher than a high school graduate’s average annual earnings¹.
If you annualize the difference in earnings, the investment in college is clearly worth it monetarily over someone’s lifetime. Thus, it makes sense that the demand for college continues to increase. With that, the competition has increased as applications are up by more than 95% in 2018-19 compared to just 15 years ago².
This has obviously had an impact on the cost of education. Since 1983, the cost of tuition has risen at a rate of 6.3% per year. To put that in cumulative terms, the cost of tuition has almost risen eight-fold (798%) over the last 35 years. Compare that to housing, where costs have only risen about 169% over that same period of time³.
The meteoric rise of college costs scares most and confounds parents when they are trying to think about the future — so what is the best way to plan for college?
Acknowledge the Uncertainty
The problem with planning for college when children are young is that there is so much uncertainty surrounding it. Will your child go to college? Where will they go? How many years will they attend? How much will it cost? How much of tuition am I willing to pay? Will they get a scholarship? What will financials look like at the time they enroll?
You can be paralyzed by variables to place into the equation. This generally causes willy-nilly decision making and even causes some to ignore the situation completely. Admit you don’t know exactly what is going to happen but try to apply some current reality to the situation by establishing a concrete starting point.
Pick a school and a number to quantify your goal
It’s probably best to begin by quantifying the situation from the beginning. Generally, when we advise folks, we take a specific approach to their location. For example, since we are located in Nebraska, we use the cost of its largest University, The University of Nebraska. The cost of tuition, fees, housing and meal plans in 2019-20 is $21,286.
Obviously, this tuition amount is in today’s dollars. Based on your child’s age and an assumed tuition inflation rate, you can come up with a four-year undergrad cost need in the future (going for more than four years is a behavioral event which we will not solve for). Then you can begin to do the math around how much is needed to fund college depending on the time horizon of your child.
When you have the numbers, you can solve for age. Below is an example of what an estimated cost of tuition will be (assuming 5% tuition inflation each year) for the University of Nebraska Lincoln. (Note: This does not include the effect of tax on any earnings/growth)
1. S. Census Bureau – Current Population Survey 2018; 2. National Center for Education Statistics; 3. BLS, Consumer Price Index, J.P. Morgan Asset Management. Data represent cumulative percentage price change from 12/31/82 to 12/31/2018
How much of college tuition are you willing to help pay for your child?
The right columns show how much you would need to save per month in order to pay for those future amounts assuming a 6% return on the assets invested monthly over the time from the beginning age. With this information, we can estimate the cost of paying for 75% of University Nebraska tuition for a current newborn would require an estimated monthly savings of $425.
To make a plan, one needs to quantify how much they would like to pay for their children’s college and then acknowledge their ability to do so. The ability to contribute to their children’s future education must be contemplated concurrently with other income, savings, liquidity and planning for retirement. We always solve for retirement first because college is easier to fund, and frankly, it is not a necessity but a desire.
The combination of the ability to pay and the amount parents are willing to pay is what still needs to be solved for. Parents need to ask themselves if they want their children to have “skin-in-the-game” and what sacrifices they will need to make to go to college. What, then, are the parents willing to sacrifice to get them there?
The shortfall amounts can be filled with scholarships, grants and loans. Financing college and paying back debt is another topic we will write about as a follow-up, but we want to give you some context. According to Savingforcollege.com, the class of 2019 will have debt totaling roughly $29,900 when they graduate. Their parents will acquire more than $37,200 in debt in addition to the children. Whatever shortfall people haven’t saved for or haven’t paid for will generally get borrowed in some fashion.
Okay, I get it, I need to start saving now. But to what vehicle?
Deciding what vehicle to use to save is determinant on the ability to have assets grow, tax efficiency, control and time. In our opinion, 529 plans offer the best way to plan for college. While there are multiple 529 options out there sponsored by each state, the one that is best for you comes down to three things.
- Do I get a tax deduction for contributions?
- Is this plan low-cost?
- Does it have low-cost and diversified investment options?
All 529 plans have the ability to defer taxes on growth and potentially have the ability to shield growth from all taxes if used for a qualified educational expense. However, each plan has a different tax treatment on contributions determined by state laws. For example, Nebraska allows for a state income tax deduction on contributions up to $10,000 annually in totality. This could save someone up to $650 annually, depending on your income tax rate. However, it is important to note that some states offer no state tax breaks on contributions such as Minnesota.
You also have the ability to maintain control of the funds and distributions that occur throughout the lifetime of your child/beneficiary. These are considered the assets of the owner (parent), not the beneficiary (student). However, these accounts can be opened up by grandparents or others on behalf of a student. These are subject to gifting limits, so please consult your tax advisor prior to opening one up.
After you decide what tax treatment you get in your state, you can narrow down the plan offerings based on cost and investment options. The types of costs you need to look at within the 529 plan are the following:
- Program manager fee (what financial institution sponsors the plan)
- Investment advisor fee (what your financial advisor collects, if anything)
- Mutual Fund expenses (underlying costs of the investments)
- State administration fees (what the state charges to sponsor the plan)
Other options are Coverdell ESAs, which are limited to $2,000 a year in contributions and are phased out based on your income levels. These are tax-deferred and tax-free if used for education. They do offer a wider array of investment options since it is a personal account. However, you also are required to move the assets to another beneficiary by age 30, or take out the assets and pay the taxes.
UTMA (Uniform Transfers to Minors Act) and UGMA (Uniform Gifts to Minors Act) accounts for minors have a few pitfalls. The first of which is children can have full control of the assets at the age of majority in the state in which they live. In Nebraska, children have sole control at age 21. These assets are also subject to income taxes and capital gains annually. Who is responsible for those taxes is based on the income level of the minor and in some cases their parents.
What if my kid gets a full ride scholarship?
Congratulations, you just won the lottery! You may have several options for their savings, depending on the account type. If it is a UTMA, it’s their money for good. If it is a 529 you can switch it to another beneficiary, do nothing and see if grad school funds are needed, take the money out (pay income tax on the growth), or distribute it to the beneficiary for other non-qualified educational needs (they pay income tax on the growth).
Just do it!
Planning for college is just that: planning. Like all plans, sometimes they will change. However, we believe it is important to at least quantify and begin saving as early as possible. You will have peace of mind and, more importantly, assets you can use to help aid in one of the most important decisions you and your child will ever make.
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
JUSTIN VOSSEN, CFP®, NAPFA + INVESTMENT ADVISER, PRINCIPAL
Justin Vossen is an Investment Adviser and Principal at Lutz Financial. With 21+ years of relevant experience, he specializes in providing wealth management and financial planning services for high net-worth families, business owners in transition, endowments and foundations. He lives in Omaha, NE, with his wife Nicole, and children Max and Kate.
AREAS OF FOCUS
- Investment Advisory Services
- Comprehensive Financial Planning
- Business Owner Planning & Succession
- High Net Worth Families
AFFILIATIONS AND CREDENTIALS
- CERTIFIED FINANCIAL PLANNER™
- National Association of Personal Financial Advisors, Member
- Financial Planning Association, Member
- BSBA in Economics and Finance, Creighton University, Omaha, NE
- St. Augustine Indian Mission, Board Member
- Nebraska Elementary and Secondary School Finance Authority, Board Member
- St. Patrick's Church, Trustee
- Mount Michael Booster Club Board
- Lutz Gives Back, Committee Chair
- March of Dimes Nebraska, Past Board Member
- A 100-Year Bet Gone Bad
- Am I Ready to Retire? Finding Your Sweet Spot
- 5 Retirement Strategies for Small Business Owners
- Outsmarting the Ivy League?
- An Investor's Year-End Wrap Up & Tax Prep
- Nobody Knows Anything
- Add "Brexit" to the Long List of Uncertainty
- Financial Planning for College Grads
- Fight or Flight - Lesson Learned
- Social Security: The New Rules
- Putting Volatility in Context
- The Asian and European Fronts
- Bubble Looming or a Bubble Popped
- Re-Emerging Markets?
- A Market Perspective
- Timing is Not Everything
- "Yellen" at the Fed
- Mind What Matters...Focus Efforts On What You Can Control
- What to do With a Financial Windfall
- Love Indexes - Hate the Indexes
- Do I Own a Market?
- A Practical Primer On Volatility
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