Last Week’s Question of the Week: In 2020, the FDIC insures a depositor against loss in a bank of up to how much per depositor, per bank, per ownership category? Is it $100,000, or $250,000?
HOST: I know that your firm specializes in retirement planning, but I assume that you also get questions on college planning and how to best plan and help your children or grandchildren?
KLAAS FINANCIAL: Yes, we do on many fronts. From parents who are trying to fund college for their kids while they are planning and saving for their own retirements to grandparents who want to know the best way they can help with funding. It is important to mention that the cost of attending college has increased by 25% in the last ten years. Still, earning a college degree remains a strong investment. In 2018, college graduates earned weekly wages that were 80% higher than those of high school graduates. So, what does college today really cost?
2 Year Colleges: The National Center for Education Statistics (NCES) reports that there are approximately 8.7 million students in the United States studying at public two-year colleges or community colleges with tuition running an average of $3600 per year. It often makes financial sense for many students to go this route, even if they plan to pursue a four-year degree as they will at least have two years at a very economical rate.
In-State Public University: The average tuition and fees at an in-state public university is about 73% less than the average sticker price at a private college, at $10,116 per year for the 2019-2020 year compared with $36,801 per year. In Wisconsin, public universities run approximately $26,000 per year for tuition and room & board.
Private Universities: There is of course a range for these across the country, but generally average around $50,000 per year for tuition and room & board, or $200,000 for a 4-year degree. Harvard and Yale today are currently running at around $73,000 per year.
HOST: So where does one start when it comes to planning for these costs?
KLAAS FINANCIAL: Well of course there are potential academic and athletic scholarships that can help with these costs. And many students and parents will likely consider taking out federal loans to help cover costs. We would discourage borrowing from your 401k plan to help fund college expenses. But outside of this, saving early (and often) is key for most families. Having a savings strategy in place will definitely help. Let’s start with 529 plans:
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. These “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. These plans commonly offer you options to grow your college savings through equity investments. Generally, most 529 plans can be used at any place of higher learning in the United States or abroad. There are two types of 529 plans: Prepaid tuition plans and education savings plans. All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a prepaid tuition plan.
It allows you to save/contribute up to $15,000 per year for your child’s college costs without having to file an IRS gift tax return. A married couple can contribute up to $30,000 per year per recipient. (An individual or couple’s annual contribution to the plan cannot exceed the IRS yearly gift tax exclusion.) If you have 3 grandchildren for example, you could jointly gift $90,000 without gift-tax consequences. If your total gifts to an individual is more than $15,000 this year, the excess amount will count against your lifetime estate and gift tax exemption and will have to be reported on Form 709 when you file your taxes. In 2020 individuals can gift up to $11.58 million without having to pay federal estate or gift tax (23.16 million jointly). There are no income restrictions for contributing to a 529 but know that contributions to a 529 plan are not tax-deductible. Earnings are exempt from federal tax and generally exempt from state tax when withdrawn, as long as they are used to pay for qualified education expenses of the plan beneficiary.
- Flexibility: If your child chooses not to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from a 529 plan into another 529 plan established for the same beneficiary (or for another family member) without tax consequences.
- Who can contribute? Grandparents can start a 529 plan, or other college savings vehicle, just as parents can; the earlier, the better. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself.
- Flexibility of distributions: 529 plans allow for flexibility of where you can use the funds. The funds may be used to pay for tuition, room & board, books and supplies, computer hardware, software, and even pay back of student loans. The SECURE Act, passed in December 2019, created new qualified expenses for 529 savings plans. Distributions can now be used for apprenticeships, homeschooling expenses, and repayment of up to $10,000 of student loans for the beneficiary and their siblings.
- No age limit for distributions (in most states): If your 32-year-old decides to go back to school, they can still use money from a 529.
- Non-qualified expenses: If you want to use the money for non-qualified expenses, you can make a distribution, but you would pay taxes on the growth, and a 10% penalty for using it for something outside of educational expenses. The person who receives the distribution pays the tax on the money taken out.
- 5-year election: This allows individuals to contribute as much as $75,000 to a 529 plan in 2020 if they treat the contribution as if it were spread over a 5-year period. The 5-year election must be reported on Form 709 for each of the 5 years. For example, a $50,000 529 plan deposit in 2020 can be applied as $10,000 per year, leaving $5,000 in unused annual exclusion per year. There’s no age limit.
HOST: What about prepaid tuition plans? Are these a good idea?
KLAAS FINANCIAL: Prepaid tuition plans let a saver purchase units or credits at participating colleges and universities (usually public and in-state) for future tuition and mandatory fees at current prices for the beneficiary. Things to note:
- A prepaid plan locks in the current rate of tuition when your child or grandchild is born, allowing them to avoid the massive price increase due. Prepaid tuition plans usually cannot be used to pay for future room & board at colleges and universities, and do not allow you to prepay for tuition for elementary and secondary schools.
- Most prepaid tuition plans are sponsored by state governments and have residency requirements for the saver and/or beneficiary. Currently they are available in 11 states and are usually portable to other universities, but the tuition rates will not be guaranteed.
- Prepaid plans are not guaranteed by the federal government. Some state governments guarantee the money paid into the prepaid tuition plans that they sponsor, but some do not. If your prepaid tuition payments aren’t guaranteed, you may lose some or all of your money in the plan if the plan’s sponsor has a financial shortfall.
- If a beneficiary doesn’t attend a participating college or university, the prepaid tuition plan may pay less than if the beneficiary attended a participating college or university.
HOST: What other education savings plans are available?
KLAAS FINANCIAL: Some people have heard about Coverdell Educational Savings Accounts. Anyone can set up an ESA at a brokerage or other financial institution, or directly with a mutual fund company. Once an ESA is opened in your child’s name, anyone can contribute as long as they follow a few rules:
- No more than $2,000 per year can be put in a child’s ESA(s) per year. Contributions may be made until the account beneficiary turns 18.
- Money must be used by the beneficiary by age 30 or given to another family member for educational purposes to avoid taxes and penalties.
- An ESA can be used for primary and secondary school, not just college expenses.
- An ESA has income restrictions. You can’t contribute to an ESA in 2020, if you make more than $110,000 (single) or $220,000 (married filing jointly).
- Contributions to Coverdell ESAs aren’t tax-deductible, but the account enjoys tax-deferred growth and withdrawals are tax-free so long as they are used for qualified education expenses similar to 529s. Nonqualified withdrawals are taxed. The beneficiary pays the tax.
- The key difference between a 529 and a Coverdell is that a Coverdell ESA operates more like a custodial account, where the funds are the property of the beneficiary and cannot be revoked.
Other types of accounts:
UGMA & UTMA accounts: These are all-purpose savings and investment accounts often used to save for college. When you put money in the account, you are making an irrevocable gift to your child. You manage the account assets. When your child reaches the “age of majority” (usually 18 or 21, as defined by state UGMA or UTMA law), he or she can use the money to pay for college. However, once that age is reached, that child can also use the money to pay for anything else.
Cash Value Life Insurance: If you have a “cash-rich” permanent life insurance policy, you can take a loan from (or even cash out) the policy to meet college costs. The principal portions of these loans are tax-exempt in most instances. Should you fail to repay the loan balance, the policy’s death benefit will be lower, however. The value of a life insurance policy is not factored into a student’s financial aid calculation. That stands in contrast to 529 plan funds, which are categorized as a parental asset even if the child owns the plan.
Visit www.savingforcollege.com to calculate what amount you may need to save for your child’s future education. You can put in how old the child is, what kind of institution they may go to, how much you can save on a monthly basis, and then find out what the gap for additional savings needs to be.
Imagine your child graduating from college debt-free. With the right kind of college planning, that may happen. Talk to a financial advisor about these savings methods and others.
This Week’s Question of the Week: Are contributions to a 529 plan tax deductible? Yes, or no?
Catch C.J. Klaas and Maleeah Cuevas on Money in Motion every Thursday on Madison's 1310 WIBA from 8:05-8:35am.