In 2004, I wrote a column called “College Cost Crisis,” which addressed the rapidly increasing costs of college. Costs were increasing at 6–8% on average per year, more than twice the rate of typical inflation. Here’s an example I used:
The cost to attend San Diego State University, including fees, books, and room and board on campus currently averages over $10,000 per year. In 10 years, at a 7% per year cost increase, the cost could reach $21,000 for a student to attend SDSU for one year.
It wasn’t a prediction but just a statistical projection that is, unfortunately, close to reality. Now 12 years out, the SDSU admissions website lists the cost for one year of school (including tuition, room, board, books and fees) for an undergraduate CA resident at $24,606 for the year.
Saving early and often can help to address the costs, but as I outlined in 2004, it generally takes more than saving to be successful. Positioning yourself for financial aid, including scholarships, and communicating with your child and even extended family on the expectations and limitations of what you can do as a parent, can be helpful. Investing should also consider the goals of outpacing the increase in cost and minimizing taxes. (You can find the “College Cost Crisis” column in the archive at www.principledprosperity.com.)
Like the tremendous rise in health care costs, it’s difficult to see college costs continuing at the same pace. The rapid movement of information through technology should increase the efficiency of education and drive competition especially by alternative means, but the need to save (at least something) shouldn’t be dismissed. According to the Department of Labor, the unemployment rate for graduates with a Bachelor’s Degree was 3.5% in 2014 compared to the 5% rate for all workers.
In this column, I want to focus on the benefits and restrictions of investing into education-specific plans such as 529 College Savings Plans.
The 529 option has risen in popularity since its creation in 1996 primarily because investment earnings can be withdrawn tax-free if used for qualified college education expenses.* The effect of compound interest can make this an attractive benefit. For example, Mr. & Mrs. Smith invest $1000 into a 529 plan when their daughter is born. They hypothetically earn 8% per year net of expenses. They would have nearly $4000 when their daughter turned age 18 — all to be withdrawn tax-free.
States administer 529 plans and partner with investment companies to manage the investments. Currently, 34 states offer a state tax deduction for residents contributing to their home state plan. (This is in addition to the tax-free withdrawal benefit mentioned previously.) California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota, New Jersey and Tennessee are the states that have state income taxes but offer no deduction. Since savers are not required to select their home state’s plan, residents of these tax restrictive states are wise to consider the investment manager and plan fees for various plans.
Coverdell Education Savings Accounts serve as alternatives to 529 Plans and work similarly in that they offer tax-free qualified withdrawals for college but also for K-12 private school tuition. They remain less popular than 529 plans, however, because of smaller contribution allowances and tighter restrictions on unused money.
The Coverdell accounts allow greater flexibility for investment choices. 529 plans offer a suite of investment choices, which can include open selection of investments offered by the manager, but are often more focused on pre-arranged investment portfolios based on certain risk levels or the age of the child. (The closer to college age, the more conservative the portfolio will become.)
Because education-specific plans are restrictive in their use, some people prefer to save for college with more flexible, but often less tax-friendly, investment vehicles. Regular investment accounts held in the parent’s name, Uniform Transfer to Minors Accounts (UTMA), or even retirement accounts which can offer flexibility to withdraw for education can address this preference.
The intricacies of these decisions can be complex, so I highly recommend the counsel of qualified advisors. A solid resource to compare the details of various college plans and also evaluate each state’s 529 offering can also be found at www.savingforcollege.com.
Chip away at the enormity of college costs. “The plans of the diligent lead surely to advantage” (Proverbs 21:5a)…
And that is just one more Principle of Prosperity!
*See IRS publication 970 for Qualified Education Expenses
Anthony Saffer, CFP of One Degree Advisors, Inc. coordinates principled financial solutions for families. Learn more at: onedegreeadvisors.com.
Advisory services offered through One Degree Advisors, Inc. Securities offered through Securities America, Inc., Member FINRA/SIPC. One Degree Advisors and Securities America are separate companies.