Experts at Financial Security Advisors discusses the perks and pitfalls to the various education savings plans available to parents.
By Marsy Gordon
One day, when my kids were young, I saw a plaque that said, “Motherhood is not for wimps.” That applies to a lot of things in life, including planning for little kids to grow up.
Many people want to save for their children’s educations but aren’t sure where to start. You work hard for your money and want to be smart about how you use it.
Whether you use a sophisticated investment plan or a piggybank, one of the best things you can do is get started. It might seem like $10 doesn’t go very far toward a college education, but just setting aside $10 every week for 18 years turns into nearly $10,000 – and that’s before any interest or dividends are added. Throw in a little extra cash (or a weekly increase) and that sum could increase nicely.
The worst savings plan of all is the “No Plan” plan. It’s easy to believe that there will be more to invest next month … or next year … or when the cars are paid off … so we’ll get started then. That wastes a lot of time and compounding, and you lose out on free money.
I recently sat down with Sandi Weaver and Nick Applegate of Financial Security Advisors (which, incidentally, is where I spend Monday through Friday each week) to get some insight into financial planning for education. Besides being a certified professional accountant, Sandi is a certified financial planner and a chartered financial analyst. Nick is a financial analyst at our Prairie Village, Kan.-based firm.
Marsy Gordon: What are some smart ways to save for a child’s education?
Sandi Weaver: 529s (529 College Savings Plans), ESAs (Education Savings Accounts) and UTMAs (Uniform Transfers to Minors Act) are all good depending on the family.
MG:How does a 529 work?
SW: 529s are offered by individual states and vary depending on the plan’s options and the owner’s preference. They are held in the parent’s name and grow without being taxed even when the money is drawn out for education. Most 529s give you a deduction on your state tax return for the amount you put into the plan each year.
Nick Applegate: Bob and Mary opened a 529 for their daughter, Sophia, when she was born to pay for college expenses. While Sophia and her college fund grow, they can get a deduction of up to $6,000 on their Kansas income tax if they put that much in each year.
SW: Ken and Lindsey opened Virginia 529 plans for their boys when they lived in Missouri because they liked the options the Virginia plan offered. They got a state tax deduction for their contributions until they moved to Colorado, which doesn’t allow state tax deductions on out-of-state 529 plans. Kansas and Missouri allow their residents to take the state deduction regardless of which state plan you use. Also, 529s can be used at any college, not just one in your state.
MG: Are there any downsides to the 529?
SW: 529s are for college, so they can be used only at an accredited college. They can be used for things like tuition, room and board, books and fees. If the child doesn’t want to go to college, the money can be transferred to another family member. That’s a nice feature.
MG: What about education that’s not at a traditional college, say, training to be an auto mechanic? Since most cars are computers-on-wheels these days, that takes a fair amount of education.
NA: It depends on the training program. Many technical and vocational schools are covered. Just be sure they are on the U.S. Department of Education’s list of accredited schools.
SW: One other good thing about the 529 is that it is held in the parent’s name, so it doesn’t count much on student loan applications such as the FAFSA (Free Application for Federal Student Aid).
MG: How do ESAs differ from 529s?
SW: Education Savings Accounts can be used for college expenses like the 529s, but they also can be used for K-12 education expenses. That’s a good deal for families whose kids go to private schools. Also, the money in an ESA can be transferred from one child to another in the family.
MG: Any negatives to the ESA?
SW: The maximum contribution each year is only $2,000 per child. Contributions can be made until age 18, and it must be used by age 30. An ESA impacts student loan applications, and there is no state tax deduction.
NA: ESAs can be a supplement, too, as Ben and Kathy found out. They plan to use Ben’s GI Bill to cover most of their son Jeff’s college expenses and use the ESA to cover additional expenses that the GI Bill doesn’t cover.
MG:What about the UTMA?
SW: The Uniform Transfer to Minors Act is an account in the child’s name, so you can take advantage of the “kiddie tax rates” (usually zero or a very small tax). The flip side is that it will count heavily against a student loan application. UTMAs can be used for a lot of things from college tuition to a teenager’s first car. Just be sure to document it. Since it belongs to a specific child it is not transferrable to other family members.
MG: Any pitfalls to the UTMA?
SW: The UTMA builds assets for a child until age 18 or 21 depending on the state. Henry and Sue had saved for their son, Tom’s, education with a UTMA. The closer he got to age 18, the more they realized that Tom had no interest in going to college. Since UTMAs can be used for pretty much any needs that are for the benefit of the child, they started charging Tom for rent, food, laundry services, etc., and set it aside for him. They didn’t want him to just blow the money in case he decided to go to school later.
NA: Charles and Jennifer live in the state of Washington where there is no state income tax. They used an UTMA for their daughter, Nancy, who started college this year, and they are withdrawing monthly now. They have a couple more years to decide how to transfer ownership of any remaining balance to Nancy.
MG:Are there any other ways to save for a child’s education?
SW: There are the traditional options of the EE savings bonds and savings accounts that can be opened at local banks. The EE bonds are not taxed when cashed if the person’s taxable income at that time is below a specified amount (currently $89,700 for an individual). We don’t recommend that people buy them for a new baby because you just don’t know what your income will be in 18 years. You could end up paying tax on the bond’s interest. Both savings bonds and savings accounts offer simplicity and low risk, but they don’t have the potential to grow as much as the other plans.
The most important action to take is to simply take action, and the sooner the better. Talk with your tax preparer and your financial advisor. Don’t wait. You don’t want to discover that college is expensive while sitting in the stands at high school graduation and swaying to the sounds of “Pomp and Circumstance.” Your pomp could be in a serious circumstance.
Marsy Gordon is the operations analyst for Financial Security Advisors, a fee-only financial planning firm based in Prairie Village, Kan. For more information, visit financial-security-adv.com.