October 3, 2019

What to Expect Financially When You’re Expecting: Part IV

Written by David Klepeisz, CFP, EA ®, Posted in

In the final part of this series, we will cover savings goals and college savings plans.

While tearfully saying goodbye to your little bundle of joy at college seems lightyears away, now is a good time to start putting some money away for college. Based on information compiled by Vanguard, the average cost of college has increased by 6% per year. Since I live in the state of North Carolina, I’ll use the University of North Carolina (UNC) for my example. UNC’s current posted undergraduate tuition cost is $20,100 per year. Projecting the current tuition cost increasing at 6% every year for a four-year degree, in 18 years, you could be paying $250,981 for a degree!

If that feels completely unrealistic, well, there’s a probability that it is. Regardless of what side of the political aisle you sit on, both parties have suggested radical changes to the current college environment; from free education for everyone to limit the amount colleges can raise costs every year. The chances of some degree of change by the time your child reaches college-age is inevitable. Now what will those changes be? No one can say with any confidence.

Additionally, it’s important to recognize that not all children endeavor to attend a four-year school. Some may go to a trade school, a community college, or simply dive in with an apprenticeship or entrepreneurial opportunity. Regardless of your child’s future plans, you will never regret saving for their (or your) future.

Here’s where I can help.

I’ll outline a few different ways you can save for college with the different pros and cons of each plan.

Let’s start with 529 plans. This is the most widely used vehicle for saving for college. It is an account created by a specific state with special tax rules for savings for college. It can be set up by a parent, guardian, or grandparent for the benefit of a child. Depending on each individual state’s plan(s) there are different rules on how much you can contribute annually or cumulatively.

Once the money is in the account, it can be invested in target-date funds or investment strategies that range from aggressive to conservative. The target-date funds become more conservative as the child approaches college age. The allocation funds invest in a specific strategy such as aggressive and doesn’t change over time.

A few of the benefits of a 529 plan: any gains on the investments are not taxable to you or the child, as long as the money is used for qualified educational expenses. If the account isn’t used up on the first child it can be used for any “member of the beneficiary’s family,” as defined by the IRS. A recent update to this plan also allows it to be used for private school education (not just college).

The downsides to the 529 plan: There is a 10% tax penalty on your investment gains if you pull money and spend it on a non-qualified expense such as transportation, sports or activities, or health insurance for your child. And that 10% is taxed at ordinary income rates, not capital gains rates.

Next, we will discuss a Uniform Transfer to Minor’s Account (UTMA). This is becoming less common for college savings because of its complicated nature. The UTMA account is set up for the benefit of the child and can be invested. At the age specified by either the state or when you set up the account, the child can receive the money usually age 18 to 21.

This type of account can be invested in a wide variety of investments without being limited, like a 529 plan; a clear pro.

Downsides of this account are that any gains could require filing a tax return every year for the child, which would be taxed at a high rate. Additionally, at age 18 or 21, the money becomes the child’s with no requirement that it be used for education. If your child wanted to take a trip to Europe rather than go to college, they can. UTMA accounts also count as assets of the child for financial aid purposes, which are counted more heavily compared to parental assets. Given these issues, we generally don’t recommend setting up these types of accounts for college savings.

Finally, there is the third option: a taxable brokerage account in the parent’s name. This is a basic investment account you can set up yourself online or through a broker. It allows you to invest in whatever you want: stocks, mutual funds, exchange-traded funds, etc. You are not limited (like the 529) based on what options are provided.

Unfortunately, this type of account doesn’t receive the same tax benefits as a 529 plan. This means any dividends or capital gains will impact your tax return every year.

There is some good news for this account. We typically recommend the parents set it up in their name, so it is under their control. This alleviates the issues raised with a UTMA, which ultimately becomes unrestricted property of the child. The taxable brokerage account also doesn’t have to be used strictly for college funding. If your child goes another route after high school, this money can be used to help however you deem appropriate.

Now that you know probably more than you cared to know about college savings accounts what should you do?

As with most things, it depends on your individual situation. I would recommend setting up a 529 plan, especially for the birthday and holiday money your child may receive from relatives. You can turn that birthday check into your child’s future education (which is probably a better long-term gift than the shiny new toy). But I would also recommend setting up a taxable brokerage account in your name and funneling some money on a monthly basis. You can invest in a low-cost passive ETF or mutual fund and invest it for growth. If we see changes to the cost of a four-year degree or college isn’t the right path for your child, this gives you a place to draw from with potentially smaller tax implications compared to the 529 plan.

I hope you have enjoyed our series on What to Expect Financially When You Are Expecting.

As always, if you would like help regarding your own financial plan (or preparing for your new financial journey as a parent) please reach out to Accruent Wealth Advisors for a complimentary consultation. I would be honored to share the journey with you.

David Klepeisz EA, CFP®

If you would like help regarding your financial plan and preparing for your new financial journey as a parent please reach out to Accruent Wealth Advisors for a complimentary consultation. Please call (336) 760-4829 or email us at info@accruentadvisors.com. You can click here to schedule your consultation today.

About the Author
David Klepeisz, CFP, EA

David was born and raised in historic Yorktown Virginia. He graduated from Virginia Tech where he studied financial planning through a CFP® board-registered program. David has also earned the professional certification of CERTIFIED FINANCIAL PLANNER® practitioner from the Certified Financial Planner Board of Standards. In addition, he has earned the professional certification of Enrolled Agent (EA) A holders are licensed by the U.S. Treasury and are the only federally licensed...