Veterinarians know better than most that higher education is expensive, and saving for college can be an enormous task. There are a multitude of questions to be considered. How much do I need to save? What happens to the savings if my child gets a scholarship or doesn’t attend college? Should I prioritize college savings over retirement savings?
When it comes to your children, these can be tough questions to answer. And it can be easy to delay saving for college, but the time to begin planning is now.
College or Retirement?
When prioritizing savings, many people believe since college has a shorter time horizon that college savings should take precedence over retirement savings. This couldn’t be further from the truth. Solidifying your personal financial goals and funding your future goals such as retirement should take priority. If you sacrifice your own goals for the sake of your children’s college, which causes you to underfund your retirement and be dependent on your children later in life, have you really done them a favor? For more on this topic I encourage you to read College or Retirement? How to Best Allocate Savings for Parents.
How Much Should I Save?
You can research different schools and visit their financial aid websites to determine how much a 4-year degree, including room, board, and miscellaneous expenses, will cost. You can use this data and compare how much you anticipate having saved by the time your child attends college by using an online college savings calculator like Savingforcollege.com or CollegeBoard, or by working with a fee-only financial planner.
Understanding estimated college costs can also aid in discussing how much of college expenses are you trying to fund. Many parents may choose to fund only a certain amount of college expenses and place the remainder under the responsibility of the student while other parents desire to pay for everything. This can obviously affect the amount needed to be saved.
Understandably, it can be difficult to determine precisely how much you need to have saved, but the process of calculating estimated costs and savings rates can provide a great framework moving forward.
Ways to Save for College
Below are a few options to consider when saving for college
Arguably the most well known college savings account, the 529 plan was created specifically for college savings. Similar to a Roth IRA, contributions into a 529 plan are made with after-tax dollars but grow tax-free within the account and if used for qualified educational expenses all contributions and earnings can be withdrawn federally tax-free as well.
Each state offers their own 529 plan, but regardless of which plan you choose you can use those funds to pay for any qualified expenses at any school in any state. The advantage of choosing your home state plan would be if they offer a state tax deduction for contributions. For example, I am a resident of Georgia and use the Georgia 529 plan. This plan allows for up to $8,000 state tax deduction per year per beneficiary for joint filers. So I have 2 children, meaning if I contribute $8,000/year to each of my children’s 529 accounts, I can deduct $16,000 from my state income tax. Even by contributing to the Georgia 529 plan, I can use the savings for any school my children decide to attend as long as the funds are used for qualified educational expenses.
If your state does not offer a 529 state tax deduction, you may not have any incentive to use your home state’s plan. In this case, consider other plans which offer low-fee investment options and age-based/risk-based investment choices.
Other 529 Plan features:
- High Contribution Limits– Joint filers can contribute up to $30,000 per year per child into a 529 plan. You are also able to ‘superfund’ a 529 by contributing 5 years worth of contributions at one time. For example, a married couple could contribute $150,000 per child in any given year, though this would prevent them from making any future contributions for the next 5 years. Contributions are not limited to parents. Anybody can contribute to a child’s 529 plan, and this includes grandparents. This can be a great idea for baby gifts and birthday presents. There are no limits to how many people can contribute to a child’s 529.
*The owner of the 529 plan can affect a family’s expected family contribution, though this may be simplified with the upcoming new FAFSA changes. Be sure to understand your options when opening 529 plans.*
- Flexibility– 529 plan savings can be used for many different levels of education. Based on the Tax Cuts and Jobs Act of 2017, up to $10,000 in 529 plans can be used for K-12 tuition. In addition, if your child receives a scholarship and won’t need all of the savings in the account, they can be saved for future graduate school expenses or the account can be transferred into the name of a relative, such as a brother or sister or other family member. This is where the possibility of overfunding an account or having a child not attend college shouldn’t prevent college savings as flexibility is built into these plans.
If savings within a 529 college savings plan are not used for qualified educational expenses, any earnings will be taxable and all withdrawals will be accessed a 10% penalty, so it’s important for any savings placed into a 529 plan to be designated for education purposes, even if not used for the original beneficiary.
For those who are wary about placing savings into an account which may or may not be used for college expenses, utilizing a brokerage account may be best. Brokerage accounts are basically investment accounts which can be used for any purpose. While brokerage accounts have no tax advantages like a 529 savings plan and can be quite tax inefficient, there are no income limitations, no contribution limits, and no penalties for early withdrawals which make them very flexible.
If you are unsure you will use the savings in a 529 plan and are looking to avoid a possible 10% withdrawal penalty, look into opening and funding a brokerage account which can be used for both college and retirement savings.
Uniform Gift to Minors Act (UGMA)/ Uniform Transfer to Minors Act (UTMA)
UGMA/UTMA accounts are basically investment accounts set up for your child to be used for any purpose, not necessarily education. These accounts are similar to a brokerage account with the difference being the assets in the account are to be used for the benefit of the child and will be transferred to the child’s control when they reach the age of majority, which may be 18 or 21 depending on state law.
18 year olds that are responsible enough to be in control of what could be tens of thousands of dollars are few and far between, thus using these accounts for education purposes are not the best option. They are also quite tax inefficient and could hinder your child’s ability to apply for aid as these assets are considered a student owned asset for financial aid purposes.
Coverdell Education Savings Account
Coverdell ESA’s are an education savings account option that offers a tax-advantaged way to save for K-12 and college expenses. These accounts not very well known, and can be used in tandem with 529 plans for education expenses. While 529 plans now allow for $10,000 to be used for K-12 private school tuition, Coverdell ESA’s can cover room, board, transportation, tutoring, and much more making them more flexible for K-12 expenses.
Contributions are limited to $2,000 per year per beneficiary making them much more limited in contributions than 529 plans.
Life Insurance Cash Value
One of the big selling points for insurance salespeople when pitching permanent life insurance policies is the ability to use cash value within the policy to make tax-free loans for expenses such as college.
For the vast majority of veterinarians we recommend term life insurance over whole life insurance for many reasons, including decreased premiums and lower fees. But for those who may already have a permanent life policy, you have options to use the cash value to pay for college expenses.
Keep in mind, by borrowing against the policy you will either need to repay the loan with interest or the balance of the loan will continue to increase, which may cause the entire policy to collapse.
Borrowing to pay for college does have some benefits, however. Loans are not considered income or assets for financial aid purposes, which can allow the student to qualify for more need-based aid than if using a 529 plan or other assets. There are also no penalties if the funds are not used for qualified education expenses as there are with 529 plans.
There are other stipulations to consider when using life insurance cash value for education expenses and it is advised to speak with a fiduciary financial planner when making loans from a policy or when considering obtaining a permanent life insurance policy.
As with all savings, the earlier you begin the better. Understand where you are in relation to your own financial goals, then calculate the approximate cost of college to better allocate the appropriate savings amount to each of your goals.
Andrew Langdon is a CERTIFIED FINANCIAL PLANNER™ and the founder of VetWorth, a fiduciary fee-only financial planning firm dedicated to serving the unique needs of veterinarians and their families.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Andrew Langdon, and all rights are reserved. Read the full Disclaimer.