Planning Ahead: Saving for the High Cost of College

Most dermatologists know that someday their kids (or grandkids) will start (if they haven’t already) applying to colleges. As a parent or grandparent, we want to do everything we can to encourage our kids to pursue their dreams through higher education. We want them to work hard so they have options to choose the right college and the right occupation.

All dermatologists also know how expensive education is. Many of you probably still cut a check each month for student loan repayment. Based on 2019-2020 data, Collage Board® states the average tuition and fees for a private college to be $36,880 annually and $10,440 per year for an in-state public university.¹ Based on these numbers, the four-year cost of a private college is likely to exceed $147,000, (unrealistically) assuming zero inflation. These figures do NOT include room and board, books and supplies, or the many other expenses college students incur.

Planning for your children to be able to attend their dream school starts well before they know what their dream school is. No matter how close your kids are to applying for or enrolling in college, you can and should save now.

Of the many questions we are asked about education planning, most center around 529 college savings plans.

What is a 529 savings plan?

A 529 is a flexible savings account operated by a specific state or educational institution—designed to encourage and help families save for future college (and K-12) education costs. It is named after the section of the tax code that provides the parameters for use. The plans offer some federal (and often state) tax benefits. Plans are also set up to minimize the impact of the additional funds on potential financial aid. 529 plans come in two general categories: savings plans and prepaid plans.

1. Savings Plans function like a 401(k) or IRA by investing plan contributions in mutual funds or similar investments. The plan should provide you several different investment options. The account will go up or down in value based on the performance of the investment options you pick.

2. Prepaid Plans let you pre-pay all or part of the costs of a specific in-state public college. These plans can be converted for use at private and out-of-state colleges. Educational institutions can offer a 529 prepaid plan, but these are not a 529 savings plan (the Private College 529 Plan is the only institution-sponsored 529 plan thus far).

What Does the Plan Pay For?

You can withdraw money from a 529 plan for any reason, but if the withdrawals are non-qualified, you may likely be subject to penalties and/or tax on any savings. You will not pay federal taxes on withdrawals from a 529 provided you use the funds to pay for qualified education expenses. In general, tuition and any costs required to attend a college, university, or other eligible institution are qualified higher education expenses.

Beginning in 2018, as a result of the Tax Cuts and Jobs Act, the definition of qualified higher education expenses (for tax purposes) was expanded to include tuition for K-12 schools—limited to $10,000 per beneficiary per year.

Room and board is generally considered a required expense, but there are restrictions, such as cost limits for off-campus housing and enrollment requirements (half-time or greater) for students. Textbooks are qualified education expenses, but study guides that are not included on the required course list may not be. Computers are not qualified, unless the hardware is specifically required by the university for attendance.

Other Benefits

There are generally two ways to fund a 529 plan. You can go directly through the fund plan manager, or work with an advisor to help pick the plan best suited for you. Just about every state has at least one 529 plan available, but plans will differ within a given state, and from state to state.

As long as the plan satisfies the basic requirements, federal tax law provides certain tax benefits to you and the plan participant. Some states (but not all) offer additional tax incentives to investors. You should research the specifics of any plan prior to investing and consult an advisor to determine any potentially favorable tax benefits.

Am I Too Late?

Maybe your child or grandchild is already in high school. The good news is that you can still benefit from tax-advantaged college savings plans.

If your most recent filings show income tax on interest, dividends, or capital gains distributions, you could have the chance to save taxes with a 529 plan. If your resident state offers a tax deduction for contributions to its 529 plan, you could benefit by opening and funding an account, and then taking distributions to pay tuition bills. Consult your financial advisor and your CPA to see if a 529 or other college savings plan could still make sense.

Retirement or Education

Nearly every reputable advisor will tell you not to save for education at the expense of funding your own retirement accounts. College planning should come after you take full advantage of your 401(k) and other retirement savings vehicles. The assets you accumulate in your retirement accounts will not affect access to financial aid. It is understandable that you might want to have adequate funds to send your kids to their dream schools, but you do not want to sacrifice your retirement planning and potentially burden your children in the future.

Why Save Now?

In addition to providing peace of mind, starting a college savings plan early in the life of the future student is the best way to ensure that you and your children will have options when it is time to apply for colleges, and helps to avoid reliance on student loans, scholarships, and financial aid.

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1. https://research.collegeboard.org/pdf/trends-college-pricing-2019-full-report.pdf