Planning and Saving for College

In this world of highly competitive job markets, it is becoming essential that your child receives a college education. Over your child’s lifetime, a college education could mean an average of $10,000-$22,000 more in annual wages and $400,000-$900,000 more in lifetime earnings versus a person who receives a high school education. Those with a college education are also much more likely to find employment and less likely to experience layoffs throughout their life. With steadily rising tuitions, having a well thought out savings plan for college is more important now than it ever has been. According to the College Board the average annual cost of tuition steadily increases.

College Savings PlansThere are many programs and savings options to help you provide your child with a chance at a quality education and a financially successful life. Among some of the options to consider are:

• A 529 Plan.
• Coverdell Education Savings Accounts (ESA).
• Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) Custodial Accounts.
• Savings Bonds.
• Tax-Exempt Municipal Securities (Munis).
• A money market savings account.

What is a 529 plan?A 529 plan is also known as a “qualified tuition plan.” Sponsored by state agencies or educational institutions, 529 Plans are savings plans that encourage saving for future college expenses. The two types of 529 Plans are pre-paid tuition plans and college savings plans. Each state and the District of Columbia sponsor at least one type of 529 Plan. Some private colleges and universities also sponsor a pre-paid tuition plan.

The Difference between Pre-paid Tuition and College Savings Plans
Pre-paid Tuition Plans allow you to purchase your child’s college education at today’s lower prices. This can be an extremely useful program given the steadily rising tuition costs. You can save thousands of dollars with this program and avoid the hassle of constantly rising tuition cost. Most prepaid tuition plans are sponsored by state governments and have residency requirements. If your child attends an in-state public college, the plan pays the tuition and required fees. If your child chooses to attend a private or out-of-state college, the plan typically pays the average of in-state public college tuition. You will be responsible for paying the difference. The pre-paid tuition plan may be a worthwhile investment for you to consider, because many state-sponsored, pre-paid tuition plans are a guaranteed investment.

The college savings plan permits you, the college saver, to establish an account for your child to pay for his or her eligible college expenses. Withdrawals from college savings plans can usually be used at any college or university, but only for eligible college expenses. If you do not use the funds for eligible college expenses, you may be required to pay taxes and penalties.

For more information on 529 Plans, visit the U.S. Securities and Exchange Commission website.

What is a Coverdell Education Savings Account (ESA)?A Coverdell Education Savings Account (ESA) is an account created to help parents save for their child’s college expenses. Your total contribution to the ESA cannot be more than $2,000 in any year. To contribute money to an ESA, your child must be under the age 18 or be a special needs child. Money placed in a Coverdell ESA is not tax deductible, but the money placed in the account grows tax free until it is given to your child.

Generally, if the ESA funds your child receives are less than your child’s qualified education expenses at an eligible college, your child will not pay taxes on the ESA funds. This benefit applies to qualified college expenses and qualified elementary and secondary education expenses, too.For more information about ESAs, visit the Financial Industry Regulatory Authority (FINRA) website.

What are Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) Custodial Accounts?The UGMA and the UTMA custodial accounts allow you to transfer money for college to your child under the age of 18 through a trust, which can be used for higher education or any other purpose. UGMA and UTMA custodial accounts are established in the name of a single child and are not transferrable to anyone else.  

To establish a UGMA or UTMA custodial account, you must appoint a custodian (trustee), and permanently transfer the money to the trust account. A custodian is a person that is given the financial duty of managing the account. The money then belongs to your child but is controlled by the custodian until your child reaches the age of trust termination, which ranges between ages 18 to 21. The termination age is determined by the state you live in and whether the custodial account is an UGMA or an UTMA. Most UGMAs end at age 18 while most UTMAs end at age 21.

Neither the parent nor the custodian can place any restrictions on the use of the money once the child becomes an adult. Your child can use the money for any purpose without permission of the custodian, so there is no guarantee that your child will use the money for higher education. Another important consideration is that custodial accounts are considered financial assets of your child and, therefore, can have an impact on financial aid eligibility. For more information about UGMAs and UTMAs, visit the FinAid website.

Savings BondsSavings Bonds have been called "the All American Investment," because they are an easy and safe way to save money and receive a good return on your investment. There are two main types of bonds: Inflation Indexed or Series I Bonds, and Series EE Savings Bonds. You simply purchase the bonds and save them in a secure place. When your child is ready to attend college or a technical school, you can cash in the bonds at your local bank or credit union. For more information on Savings Bonds, visit the Financial Industry Regulatory Authority (FINRA) website.

Tax-Exempt Municipal Securities (Munis)Tax-exempt municipal securities are another way to save long-term without the obligation of paying federal taxes. In many cases, local and state taxes may also be exempt from these types of investments. Although Municipal Securities are considered relatively safe compared to investments in stock, they are still subject to market and credit risk. In other words, the chances of receiving a positive return on your investment depends on the bond market, changes in interest rates, and the financial stability of the state, or local government entity issuing the security. For education planning, two popular municipal securities typically used are Municipal Bonds, and Zero-Coupon Municipal bonds.

Municipal Bonds (Munis)
Municipal bonds are debt obligations issued by a state, cities, counties, or other public entities to help raise money to develop projects that benefit the public, such as schools, hospitals, roads, and airports. If you purchase munis, you will receive periodic interest payments, typically on a semi-annual basis, until they mature. The interest you receive is based upon a fixed interest called a “coupon.” Depending on the date of maturity and current market interest rates, a municipal bond may be sold at a premium (an amount higher than its principal or “par” value at original issue), or at a discount (an amount lower than its principal or “par” value at original issue).

Zero-Coupon Municipal Bonds
Zero-coupon municipal bonds are different from standard municipal bonds in that you would not receive periodic interest payments. Additionally, zero-coupon bonds are typically offered at a deep discount from their original face value. When the bond matures, you receive one payment that equals the total interest earned, plus the face amount on the bond.

Municipal bonds are appealing to many long-term investors and people planning for their children’s education because they have the potential to provide returns that are higher compared to the returns from taxable fixed-income investment vehicles. To understand more about municipal securities and their tax advantages, visit the Investinginbonds.com web site. Purchasing these bonds may have tax implications for you, so we also recommend that you consult with a tax professional.

Money Market Savings AccountsA money market account is a type of savings account offered by most banks and credit unions. The difference compared to a savings account is that a money market account usually pays higher interest, has higher minimum balance requirements (sometimes $1000-$­2500), and only allows approximately three to six withdrawals per month. Another difference is that, similar to a checking account, many money market accounts will let you write up to three checks each month. For more information about money market savings accounts, visit your local bank, credit union, or mutual fund company.

For more tips on saving, planning, and budgeting for your child’s college expenses, consider taking our Building Your Wealth online course.

Disclaimer
Each college saving option has advantages and disadvantages that may impact your child’s eligibility for financial aid and may have tax consequences as well. The foregoing material we have provided is intended for basic educational purposes only and does not purport to be comprehensive and should not be relied upon as professional tax or legal advice. We highly recommend that you consult with a trusted financial professional, your local bank, or a knowledgeable tax advisor or attorney. They can help you evaluate the various college savings plans available and determine the best option for you and your child.

The material provided herein is general and for basic educational purposes only and does not purport to be comprehensive. We are not attorneys, tax accountants, or brokers. Nothing contained herein should be construed as legal, accounting, tax or other professional advice. You should consult with a licensed attorney, accounting or tax professional for any specific questions you may have regarding your situation and should not rely on any information contained herein as being a substitute for professional legal, tax or accounting advice.

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