The Best Tools to Save for College
by Ryan W. Smith
College is one of the most formidable expenses a person has in life. Many students will rely on loans to pay for at least a portion of the cost, but in recent years tuition expenses have outpaced increases to student loan programs making savings an even more important piece of the puzzle.
According to the College Board, average costs for the 2015-2016 academic year, not including tuition have more than doubled in 15 years, a trend that is likely to continue. For the current year, in-state residents pay an average of $9,410 at public universities or $23,893 out-of-state. By 2030, at 5% inflation, less than the average 6.5% rise in the past 2 decades, those costs will rise to $18,630 per year for in-state public university students and $47,306 for out-of-state students.
For private universities, average costs will rise from $32,405 for the 2015-2016 academic year to approximately $64,159 in 2030 at a 5% annual increase. And those numbers are only for tuition. Room, board, living expenses, books, travel costs home all increase those numbers substantially.
With even average costs for an in-state public education, in total, running more than $150,000 for a four year degree and student loan maximums struggling to keep pace, finding new ways to save is important.
Here are some ways to save for college:
1) 529 Savings Plans
529 Plans are named after their location in the IRS code, section 529. These plans allow investments to grow tax-deferred with amounts drawn tax-free if used for approved educational expenses. While both 529s and the related Education Savings Accounts (ESAs), discussed below, were written with federal tax considerations in mind, only 529s also have significant state-level tax benefits as well. Some plans even include grant matching or scholarships.
There are two types of 529 plans. The Prepaid Plan allows tuition credits to be purchased at today’s rates for future use. The return on this investment is therefore tied to the rise in tuition cost and plans are administered by the state or the education institution where the credits were purchased. The other type of 529 plan is an IRA-style deposit account where assets can grow tax-free and withdrawn without penalty if used for educational purposes.
529 plans have one additional benefit that many are not aware of, which is that up to five years of exclusion gifts can be funded in a single year. These tax-free gifts, capped at $14,000 per donor and recipient per year, can be “super-funded” for all 529 plans not owned by a trust. As an example, a married couple could fund 529 plans for 3 grandchildren with $420,000 in one year. That is, $14,000 per child per grandparent or 3x2x$14,000. The only downside to this side of a 529 plan is that if the donor passes away during the five years that were already funded, the years after their passing would automatically revert back to the donor’s estate.
2) Coverdell Education Savings Accounts
Coverdell ESAs, formerly known as Education IRAs, are similar to 529 plans in that investments can grow tax-deferred and amounts drawn tax-free for qualified education expenses. Coverdells, however, also allow for withdrawal for primary and secondary school tuition, books or uniforms. One key difference is that ESAs have a yearly per child maximum contribution of $2,000. All contributions must be used by the time the beneficiary is age 30 or a new, under 30 beneficiary has to be designated.
3) Revocable Educational Trust
Like their more well-known brethren, revocable living trusts, commonly part of an estate plan, a revocable educational trust can provide flexibility for investors looking to set aside money for the education of their children, grandchildren or other beneficiaries but do not yet want to make the gift permanent.
The goal of all revocable trusts is the focus on legacy and the future while still allowing the investor control over the account. A client can serve as the trustee on the account and have total control over any distributions. Assets can be added each year without gift tax consequences because the gift is never technically completed due to the revocability of the trust itself. Assets can distributed to a permissible beneficiary for educational purposes or the trust can be revoked or restated as a different type of trust if the assets aren’t utilized.
One thing to note about revocable educational trusts is that while the investor is alive, they are considered “Grantor Trusts” for federal tax purposes. Investment strategy coordination and tax efficient planning should be considered in conjunction with these instruments.
One final positive for Revocable Educational Trusts is that those trusts created by grandparents do not have to be disclosed as an asset for student financial aid declarations so long as the trust is revocable by the grandparents and all rights to the assets are at the complete discretion of the grandparents.
4) Demand Trusts
Demand trusts, sometimes referred to as “Crummy Trusts”, are often used to buy life insurance so there is an increased likelihood they will not usually be funded fully until death of the investor. However, in some cases they can be used to hold funds that can pay a beneficiary’s expenses. Used correctly, these trusts will include a demand right that allow annual transfers into it which quality as exclusion gifts.
College costs are growing as fast as healthcare in many areas of the country. Given current trends, the vast majority of students will need to have many costs covered before ever registering for classes as student loans will only be able to fund a portion of total costs. There are many avenues that parents, grandparents and other loved ones can assist children with college expenses, so it is important to know how best to help college-bound loved ones get down the road to a diploma.