College Planning Accounts
My wife and I are expecting our first child. With all of the excitement and planning of setting up the nursery and getting the crib and diapers, one equally important piece of planning is beginning the baby’s college savings. There are several different options when saving for college, so we wanted to make sure that we decided on the right option for us and our child. We discussed different options, advantages, and disadvantages on our evening walks together to decide the best option for us. With the average price of college already at $25,000+ per year and rising, we feel it is important to get started as soon as we can.
529 Plans: One of the most common types of saving accounts for college is the 529 plan. This account has the tax advantage that all earnings are tax-exempt if the funds are used for qualified education expenses. Those qualified expenses include tuition, room, board, computers, and up to $10,000 in K-12 tuition. They can also be used for student loan payments and apprenticeship programs. A 529 plan works great if you plan for your child to attend postsecondary schooling or plan to use the funds for K-12 tuition. The funds can even be transferred to another qualifying family member such as a sibling or cousin if they aren’t used by the intended child. A potential drawback of the 529 plan is that earnings could be taxable and have a 10% penalty applied if withdrawals are not used for qualified education expenses. Another advantage is only 5.64% of parent-owned accounts are counted as assets of the student, so this account type may be more beneficial to help the student in qualifying for financial aid. If pursuing a 529 plan, it is just as important not to overfund as it is underfund to avoid the 10% penalty. However, with planning, the 529 plan can be an excellent tool for education funding.
UTMA Accounts: Another popular option is the Uniform Transfer to Minors (UTMA) account. If you don’t like the potential penalty in a 529 plan account and want more flexibility on how the funds can be spent without worrying about that penalty, this can be another great option. An UTMA account allows you to save money in an account in your child’s name, with the funds controlled by a custodian and used for their benefit while they are a minor. Once they reach the age of majority, between 18 and 21 (age 21 for UTMA’s in Texas), the funds are then transferred to the child to use at their discretion. One obvious drawback of this type of account is that a child might not use those funds responsibly at such a young age. Another concern is that for financial aid, this type of account is treated as the child’s funds, which is not as beneficial as a 529 plan where only 5.64% of the account is counted. Finally, this type of account is not tax deferred, so tax is paid on earnings as they are incurred. Earnings beyond $2,200 per year are also taxed at the parent’s tax rates through the “kiddie tax”. Smaller UTMA balances may not generate enough earnings to owe any tax, but as the balance grows and earnings increase beyond the $2,200 each year, some tax may be owed on the earnings.
Both 529 Plans and UTMA accounts are good options to use to save for a child’s college. The average tuition is currently over $25,000 per year for an in-state student attending a public 4-year institution, which amounts to over $100,000 for a 4-year degree. With education costs rising at nearly 8% per year, it is important to start planning early for college savings. Reach out to a CERTIFIED FINANCIAL PLANNER™ Professional to help reach your education funding goals.
Published in the Victoria Advocate
David Faskas is a CFA and CFP® Professional with KMH Wealth Management, LLC. He specializes in investments and portfolio management. He is the Chief Investment Officer, Chief Financial Planning Officer, and a managing member of the firm.