For many parents in the DC area, investing in their children’s future is a top priority. From a full calendar of enriching activities, to sports, and of course, academics. This culminates for many students and parents with finding and attending the right college upon high school graduation.
Also of importance is annual review or check-up on your plan for paying for higher education costs. As paying for college will be one of the largest expenses incurred during most parents your lifetime. Also, with interest rates moving higher, the cost to pay for college even partially using loans has now moved substantially higher. This makes saving for college more important than ever .
Whether you are starting your college savings journey are already along the path, here are some key elements to consider.
1.When to Start
One of the key principles in successful investing is that time is your best friend. This is never truer than saving for college. Parents have a much shorter time frame to save for higher education as opposed to their own retirement. Tuition costs have leveled off somewhat since the Pandemic but from 2010 to 2020 were averaging increasing by 4.63% per year.
An education savings component is a key piece of any financial plan for parents with children. New parents are encouraged to establish a saving account for their child within the first year. Even if you can only begin contributing modest amounts such as $50-$100 per month – the benefits will accrue and grow over time.
Planning note: Just as time can be used to your advantage is can also be used to your detriment. As you approach using your investments parents are encouraged to closely review the level of investment risk in their accounts.
For parents with older children who have not started to save – there is never a better time than now. Even some level of savings will free-up future cash-flow by not having to utilize large amounts of income when children ultimately leave the home.
2. Where to Save
There are a number of different ways to save for college including using traditional saving or investment accounts. However, there are unique benefits to saving for college in specific account types designed for education. While options such as Coverdell ESA accounts or custodial accounts are possibilities the vast majority of families in the DC area will choose to utilize a 529 Savings Plan.
529 Plans Key Benefits and Pitfalls
o Offers tax-free investment income and growth if used for qualified education expenses
o State tax-deduction for contributions (up to limits) for Virginia, Maryland, and DC plans
o Can be transferred to family members if not fully used
o Like with all investing requires investment risk and can lose value
o If not used for qualified education expenses may be subject to taxes and penalties
Another Savings Option – I bonds
Another option to save for college is using US Treasury I-bonds. The interest rate on these bonds is tied to inflation and currently offers attractive rates. They also have the added benefit of the interest not be taxable if used for higher education costs. This leads to a similar tax structure and features as a 529 plan. However, it comes with the additional value of flexibility. If the funds are not used for college, they can easily be re-purposed for other goals or retirement objectives.
3. How Much to Save
Building a savings plan Ultimately depends on your objectives for how much you support would like to provide. Parents come from different experiences and backgrounds surrounding college that ultimately shape their views and goals.
Planning thought: It is recommended for parents to have a joint discussion and decision on a specific goal for college funding. I.E. cover 75% of the costs for in state schools. As well as discuss their views on costs and potential use of loans.
One of the largest factors in determining costs and price will be the decision for attending in state schools versus out of state. This is also a difficult factor as of course you will not know your children’s academic interests until years later. With greater school choices in Virginia parents are advised to at a minimum plan to cover 100% of in state costs. Parents from Maryland and DC may wish to consider higher funding amounts.
In deciding how much to save it is important to evaluate your own savings levels and progress towards retirement objectives. You can use our retirement savings checkpoint to assess your progress. While higher education and supporting children is important for many parents – there are ultimately loans for college but not for retirement.
Common Education Saving Mis-conceptions
In talking with parents, I often find there are a variety of misconceptions and misnomers with the way local college savings plans work. Here are a few of the most common items:
I don’t want to overfund my kids 529 Plan
o A commonly mis-understood element to 529 plans is that principal contributions can be taken out without penalties. For example, if you put $50K into a plan that grows to 100K you can take out your initial 50K. This helps elevate some degree of overfunding risk. However, pro-rata rules apply and tax impacts would still exist.
o 529 plans can also be transferred between kids. This means for parents with multiple children you can almost think of the funds as “one-pot”. Again, this helps if one child goes in state and another goes to a more expensive out of state school.
The tax-deduction benefit is limited by parent
o A very common misconception in Virginia is that the state tax deduction is only by account. Multiple investment options count as multiple accounts. This allows parents who are looking to highly fund accounts a valuable additional tax benefit.
529 plans are low risk
o 529 plans have risk that is ultimately driven by what investment choices you elect. Target enrollment funds are not void of risk and vary greatly between providers. It is highly advised for parents to review their investment options, performance and risk on at least an annual basis
I can’t “over-save” for college
o While generally there is a greater likelihood of parents underfunding college savings – it is entirely possible to contribute too much to 529 plans. Balances that are not used for qualified education costs may be subject to taxes and penalties. If grandparents or other family members also have accounts these need to be factored into the total education support equation.
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GuidePoint Financial Planning - Reston Financial Planning
Ryan Phillips, CFA, CFP® is the founder of GuidePoint Financial Planning. He is passionate about helping busy families plan, save, and invest for their financial future. Contact him today if you are interested in learning more about the benefits of working with a fee-only (no-commission) financial planner.