A primer for parents on college savings accountsAs students head back to the classroom, it’s a reminder for parents that college is creeping ever closer. And its costs keep rising – about 5.4 percent a year, according to Fidelity Investments.
By: Sherri Richards, INFORUM
- Overview information: www.savingforcollege.com
- North Dakota’s 529 plan: www.collegesave4u.com
- Minnesota’s 529 plan: www.mnsaves.org
As students head back to the classroom, it’s a reminder for parents that college is creeping ever closer.
And its costs keep rising – about 5.4 percent a year, according to Fidelity Investments.
Fidelity estimates that an average family sending a student to a public college or university will need to pay roughly $14,500 to $16,000 per year from income, savings and loans. For a private four-year school, the yearly estimate is $28,500 to $32,500.
Figures like that send parents’ heads spinning, said James Barnhardt, who works with North Dakota’s College SAVE 529 Plan.
“You get brain freeze. ‘How am I going to possibly save that amount of money?’ Because you can’t. Your goal should be to save enough money, that along with student loans and grants and work study, that you can graduate your son or daughter debt free,” Barnhardt said.
Where do you save the money?
Parents wanting to save for their child’s college education have several investment options. Here are some common mechanisms for college savings:
- 529 savings plan: Each U.S. state has at least one 529 plan available, and these can be used to meet qualified education expenses at colleges nationwide. Anybody can participate in any state’s plan, though there are often incentives for in-state residents.
A 529 plan allows non-deductible contributions to grow tax-deferred in mutual funds or other investment options. Qualifying withdrawals are tax-free. The participant, usually the parent (though anyone can set up a 529 for any other person), retains control of the account rather than the child, or beneficiary, and is counted as a parental asset in financial aid calculations.
The maximum investment is set by the program; in many cases, it’s more than $300,000. North Dakota’s plan allows a lifetime contribution of $269,000.
Some states also offer 529 prepaid plans that allow parents pre-pay in-state public college education.
- Coverdell Education Savings Account: Formerly known as an Education IRA, these accounts operate much like a Roth IRA, in that non-deductible contributions grow tax-free. It can be withdrawn tax-free for qualifying college as well as K-12 educational expenses.
There is a yearly contribution limit of $2,000 a year per beneficiary, though there are income restrictions on who may participate. The account must be fully withdrawn by the time the beneficiary reaches age 30.
- UGMA/UTMA Custodial Accounts: The Uniform Gifts to Minors Act/Uniform Transfers to Minors Act allows someone to make gifts to a child without setting up a trust. There is no contribution limit or income limits, and anyone can contribute. The child pays the taxes.
It is an irrevocable transfer, and may be included as a child’s asset when determining financial aid eligibility. There are no restrictions for qualifying expenses, but it also does not have to be used for educational expenses. The child has control over the money once he or she reaches legal age.
“Generally, that’s not a real good route to go,” Ray Morgan, a financial adviser and general partner of Great Plains Financial in Fargo, said about UGMAs.
“Really, I prefer the 529 over Coverdell,” Morgan said. “Coverdell, they’re a good idea, obviously, but they’re pretty restrictive.”
Morgan said families should compare 529 plans from several states, looking for incentives, tax credits and matching grant programs, as well as a low expense ratio.
Families can sign up for 529 accounts on the state plan’s website. Coverdell plans can be opened at a bank, through a brokerage house or a financial adviser.
How much should you save?
It all depends on your family’s priorities.
Morgan said parents need to make sure they have enough money for daily expenses, insurance and retirement accounts first.
“College sometimes gets to be a secondary thing because there are other priorities that are higher up the food chain, so to speak,” he said. “It’s always a priority for parents to fund part or all of a college education for their child, but with the way the economy is right now, there’s always that question, am I going to have enough for my retirement? My family’s goals and my goals have to come before my child’s education.”
Duane Emmel, a financial counselor with the Village Family Service Center, suggests building up an emergency fund first. Saving for retirement should come before child’s education.
What’s most important, Emmel said, is making the commitment to contribute to the account, such as through automatic payroll deductions or account transfers.
Saving, of any sort, teaches discipline, establishes it as a habit, and is an example for children, he said.
“I think one of the most important things we can teach our children is money is a limited resource,” he said.
When do you start saving?
“The sooner you can start an education fund, the better,” Morgan said.
Barnhardt points out that North Dakota’s 529 plans can be started with as little as $25. “If we just talk about saving $25 or $50 a month consistently, it’s amazing what you can accumulate between 3 and 18,” he said.
Readers can reach Forum reporter Sherri Richards at (701) 241-5556