Domenica Lurvey
College tuition planning is important for many families. Knowing that you will be able to provide options for your child down the road means that in many cases, parents begin planning for college when children are quite young. The good news is, there’s no one right way to approach college tuition planning. Instead, families can choose from a range of strategies, each with its own pros and cons. The goal is to strike the right balance between saving as much as you can afford to save for college, while protecting your own long-term financial future.
COMMON STRATEGIES FOR COLLEGE TUITION PLANNING
All families should work with their financial planning advisors to devise specific college tuition planning strategies. Factors including the number of children in your family, your income and your larger financial goals must be taken into account when determining which of the following college savings vehicles might be part of your plan.
- 529 plans: Opening a 529 plan is often the first step parents take when they start thinking about college planning. There are pros and cons to using 529 plans. Flexibility and favorable tax treatment are two of the main advantages. Just about anyone can open or contribute to a 529 plan that’s established for a child’s benefit, and the beneficiary can use the money tax-free to pay for qualified educational expenses (including secondary school tuition). Contributions made to a 529 plan may also be tax-deductible at the state level, assuming contributors are residents of the state where the plan is established. If you’re pretty confident that a child is college-bound, a 529 plan might be a good place to do some tax-advantaged saving for those expenses.
- Education savings accounts: Compared to 529 plans, education savings accounts (ESAs, also known as Coverdell ESAs) have more limitations. No more than $2,000 per year may be added to one beneficiary’s ESA per year. Contributions aren’t tax deductible. And, income limits mean you will not be able to contribute to a child’s ESA if your modified AGI is above a certain threshold. For those reasons, ESAs may not be part of your family’s college tuition planning strategy at all; or, ESAs may be used to supplement other savings.
- Roth IRAs: While Roth IRAs are traditionally used for retirement planning, these accounts can also be used for college tuition planning. Why might you want to save for college expenses with a Roth IRA? Well, you might not want to—however, maximizing your Roth contributions could be part of how you create a college savings safety net. Let’s say you make your after-tax contributions to your Roth IRA every year and let that money grow tax-free, earmarked for retirement. Then you lose your job, or some investment fails, just as your child is entering college, and there’s not nearly enough in their 529 to cover the costs. Pulling money from a Roth IRA could help you cover tuition in that scenario. Early distribution penalties are waived when Roth IRA funds are used for qualified college expenses. If you end up being able to save enough for a child’s tuition through a 529 plan and other savings, you can leave your Roth IRA alone and let that money keep growing for retirement.
- Liquidating investment assets: Selling investment assets could be part of your plan to finance a child’s college education. It could be a risky strategy, in many ways. (What happens if the asset you’ve reserved to sell for college money suddenly loses half its value just before you intend to sell?) There are also complex tax and investment strategy questions to consider. Using your investment portfolio to finance college tuition may not be the most efficient way to save, so it’s an idea that definitely requires input from your financial advisors.
BROADER FINANCIAL IMPLICATIONS OF COLLEGE TUITION PLANNING: QUESTIONS TO CONSIDER
WHAT HAPPENS IF TUITION IS LESS THAN YOUR SAVINGS?
Often, parents are so worried about saving enough for college that they don’t consider what will happen if they save too much and have unused funds in a college savings account. What if your child gets a full athletic scholarship, or is passionate about a career path that doesn’t include college? Great—but what about that $200,000 you saved in their 529 plan?
It depends, at least for 529 plans. In Massachusetts, the U.Fund 529 plan allows you to withdraw money penalty-free if the beneficiary gets a scholarship, but you’ll still pay taxes on any earnings the account has accumulated. (Because you make 529 contributions with after-tax money, the dollars that you put into the account aren't taxed when you withdraw them.) If the beneficiary doesn’t pursue any kind of higher education, the account owner can withdraw all the money and pay a 10 percent penalty, plus taxes on earnings. A 529 account can also be rolled over to another family member for their benefit. If one child doesn’t go to college, a younger sibling can use the money, or a parent could even use it to further their education.
Protecting against the possibility that a child won’t need college money is one reason you might want to include a Roth IRA and/or other accounts in your college tuition savings strategy. You’ll have some money earmarked there that you’re prepared to use for college expenses. If the child chooses some other path, that’s more retirement savings for you.
WHERE ARE WE DIVERTING COLLEGE SAVINGS FROM?
When you look at projected college costs, you might feel pressure to divert every spare dollar into college savings for your kids or grandkids. Prioritizing their education costs is an admirable instinct, but you don’t want to sacrifice your family’s overall financial future to save for potential college costs. Look at how much money you’re able to put into savings and investments each month, and consider whether you're allocating it wisely. Have you pulled back on retirement savings to save more for college? Have you tapped into your emergency savings or investments to move money into college savings accounts? If yes, are there budgeting things you can do to free up more money for college savings without sacrificing your own savings and investments?
WHAT ARE THE TAX IMPLICATIONS OF OUR CHOSEN EDUCATION SAVINGS STRATEGIES?
Don’t skip this conversation with your financial advisors. Make sure you’re clear on things like: Which contributions are deductible? Do you understand the circumstances in which you’re able to take 529 withdrawals tax-free, and which withdrawals will incur taxes? How will your college savings strategy affect your overall tax bill this year? How might your tax picture change once your child actually starts college? Get these questions out of the way so there are no surprises at tax time.
MINIMIZE STRESS BY TAKING ACTION.
Sachetta’s financial advisors know that, just as no one school is right for every student, there’s no one “right” way for every family to save for higher education. We work with parents and grandparents on college tuition planning to maximize their investment dollars without neglecting their own goals around wealth accumulation. In other words: we’ll help you make the financial plans that work for everyone in your family. Contact us today!
Domenica Lurvey, MSM joined Sachetta in 2023 and works mainly with Wealth Management Clients. Domenica has a Bachelor's Degree in economics and political science, as well as a Master of Science in Management (MSM) Degree from Merrimack College. In her spare time, Domenica enjoys spending time with her friends and family, traveling, gardening, and trying new recipes.