I am often asked, “When should I begin planning financially for my child’s education?” While the answer of “at conception would not be too early”, most parents wait to think about it until sometime between birth, and their child’s senior year of high school. The most important factor in preparing for the expense of your children’s college education is time. The sooner you start saving the easier (better) it is. There are also several types of financial aid that may be available. The aid may be based on financial need, special skills (such as academic, athletic, or talent in the arts), contest winners, or simply because you are a left handed, red-head. It is important to not only apply for government grants, but also to research the thousands of scholarships provided by a large number of private organizations. This information can be obtained by searching on the internet and talking to your high school counselor. If you do not qualify for a grant and the parents cannot afford to pay for a child’s schooling, a college load, or part-time job may be required. Often, the final solution is a combination of several of the above sources.
Since you will not know if your child will qualify for any scholarships until their junior or senior year of high school, many parents start saving for their child’s college education as early as possible. But, what is the best way to save? There are several types of college savings plans available each with its own set of pros and cons. The following outline may help your understanding, and the need to consult with a financial advisor that can address your specific needs, as each person’s situation is unique.
UTMA/UGMA Custodial Accounts; The Uniform Transfer to Minors Act and the Uniform Gift to Minors Act Custodial accounts are the oldest forms of accounts used for college planning. They are often opened at a bank or savings and loan, although they could also be in the form of a brokerage account or other investment.
PROS: Easy to open, no minimum requirement. Gain taxed as part of the child’s income which is usually lower than the parents. Easy for relatives and friends to contribute. The funds are not limited to college expenses.
CONS: Assets in the account are the property of the child and the parents have no control over the account at age 18. The value of the account is used in determining needs-based financial aid awards.
COVERDALE ESA: A Coverdale Educational Savings Account is similar in some ways to an UTMA/UGMA in that it is opened in the name of the child, and quite often is in a bank or savings and loan, although it may be in a brokerage account also. However, the custodian is the financial institution rather than the parent.
PROS: The investment grows tax free until withdrawn. It may be used for any educational expenses including private school prior to college.
CONS: There is a limit of $2,000 per year per child. The 3rd party custodian has ultimate control over the account until the child is 18.
529 COLLEGE PLANS: The most common plans used for college planning. Each State has at least one plan in association with a mutual fund family. In California, the 529 plan is sponsored by TIAA-CREF. However, there is no penalty for using another State’s plan. The rules for each State are set individually and may differ from State to State.
PROS: The account is controlled by the parent rather than the child or third party. The effective contribution limit is governed by the gift tax limit (currently $14,000 per person per year), with a maximum account value of between $220,000 to $310,000 depending on the State. Grows tax deferred and may be withdrawn tax free (federal tax) if used for educational purposes.
CONS: In California, withdrawals are subject to State income tax. If not used for educational expenses, subject to ordinary income tax and penalty. Investments limited to mutual funds offered by State’s plan. Subject to market risk, value of account may lose part of its value in any given year. Value of account counted toward financial needs award.
CASH VALUE LIFE INSURANCE: The cash value in a permanent life insurance policy is sometimes used as a source of funds for college expenses.
PROS: Proceeds may be taken out tax-free. Funds not limited to any specific use. No direct investment in the stock market, therefore not subject to market loss. Parent retains control of funds.
CONS: Insurance policies are medically underwritten if the insured is the parent.
What type of plan is most suitable for your family is a complex issue and should be discussed with a professional financial advisor. Contact Russ Morris at Russ Morris Financial to schedule a complimentary consultation to discover which financial planning option for your child(ren)'s education is best for your family's situation.