Planning for College Expenses

March 23, 2022

College Graduate

In the 21^st century, the cost of college tuition has nearly doubled. The annual growth rate of college tuition has been 6.8%. The cost of college tuition is growing at a rate that is significantly outpacing average annual inflation. If you plan to pay for a child or grandchild’s college tuition, keeping the funds in cash and not investing it in the years leading up to the tuition bill can be very costly. There are many tools and outlets that parents and grandparents can use to save for their descendants’ college tuition. It is important to utilize these tools to put yourself in the most advantageous position to fund these college expenses.

Source: https://educationdata.org/average-cost-of-college

529 Plans

529 Plans are tax-advantaged savings plan designed to encourage savings for future education costs. They are also known as qualified tuition plans. They are sponsored by states, state agencies or educational institutions. Section 529 of the Internal Revenue Code authorizes the use of 529 plans in law.

All 50 states and the District of Columbia sponsor at least one of the following – prepaid tuition plans and education savings plans. This article will most likely be directed towards residents of New York State. With that being said, the New York 529 plan allows for an education savings plan. By making contributions to the NY 529 plan, you are investing the money and growing it to outpace inflation and increase it’s purchasing power. This allows the payor of the tuition to be better prepared when the tuition bill comes due. The growth is tax-free, and the withdrawals are tax-free if the funds are spent on qualified education expenses.

Contributions to New York 529 plans are considered gifts to the beneficiary of the account at date of contribution. A 529 plan is not considered when calculating the value of the owner’s estate. In addition to this benefit, contributions to New York 529 plans allow for an annual state deduction of $5,000 for each individual taxpayer. There is no income limit or phaseout amount for the deduction.

There are many other benefits to 529 plans. Another clause within the 529 plans is that if the beneficiary on the account does not use the funds as expected, the beneficiary can be changed to a sibling. 529 Plans are a great tool for parents and grandparents to save for future college expenses.

Coverdell Education Savings Account

In 2002, the Education IRA was renamed the Coverdell Education Savings Account. Coverdell ESA’s are another tool that allows parents and grandparents to save for college. In 2002, the contribution limit was increased from $500 to $2,000. If contributions exceed $2,000 in a year, a penalty will be owed.

Coverdell ESA’s are very similar to Roth IRA’s. Coverdell ESA’s allow contributors to make annual non-deductible contributions to a specially designed designated investment trust account. The account will grow free of federal income taxes and withdrawals from the account will be completely tax-free as well if they are used to fund qualified education expenses. Although, there are income limit phaseouts on contributors to Coverdell ESA’s, which differs from 529 plans. The investments are also self-directed in Coverdell ESA’s, unlike 529 plans in which the investments are managed by a fund manager. This gives the account more flexibility and could allow it to be subject to more growth if performance is more than satisfactory.

Coverdell ESA’s only allow a small contribution of $2,000 per year per beneficiary. This is most likely not enough to fund 4 years of college, but it is a great supplemental tool alongside the 529 plan. 529 plans do not have contribution limits which makes it easier to fund all the college tuition for one beneficiary.

Importance of Planning

Planning for your descendant’s college is so important. With tuition growing at 6.8% annually, the purchasing power of money when compared alongside college tuition rapidly declines year in and year out. If you don’t plan early, the cost of college tuition inflation will affect the payor of the tuition severely.

In addition to college tuition inflation, many student loan interest rates are so high that the loans become almost impossible to pay off for former students. The interest rate costs can also be very severe if the tuition is not planned for and paid for in cash.

529 plans are the best outlet that can be used for saving for college. Coverdell Education Savings Plans are a great supplement to a 529 plan. Either way, contributing something is better than contributing nothing as the cost of contributing nothing can be detrimental to an individual’s overall financial picture.

If you are in need of college planning guidance or have questions about setting up any of the discussed accounts in this article, please feel free to contact our team for a discussion.

Bouchey Financial Group is a fee-only, fiduciary, financial advisory firm with locations in Saratoga Springs & Troy, NY.