Plan Ahead To Take Advantage of College-Savings Options

College graduation season begins across the United States every May, as young adults proudly make their way across the stage, diploma in hand. This month also is an excellent time for parents and grandparents of young children to think about – and plan for – their own offspring’s higher education.

According to FinAid, a good rule of thumb is that college tuition rates will increase at about twice the general inflation rate. On average, tuition tends to increase about 8% per year.  An 8% college inflation rate means the cost of college essentially doubles every nine years. Because of higher-education inflation rates, it’s never too soon – for parents and, if desired, grandparents – to integrate higher-education savings into their overall financial plan.

This month’s newsletter offers information on college savings options. It also is intended to give you a glimpse of the complexity involved in decision making. The attributes of these savings options should be considered in light of your personal financial situation as well as their potential impact on financial aid eligibility.  

Our key takeaway: make time and take advantage of The Poindexter Group’s financial planning expertise. With guidance, you can develop a plan that optimally benefits your college-bound child/children as well as yourself.

Income vs. assets

Income has the greatest impact on eligibility for need-based financial aid received by the Federal Government or by the colleges themselves. Assets also play a key role, and recognizing the effect assets have on these calculations is important. However, several types of assets are excluded in determining Federal Financial Aid eligibility. They are: traditional IRAs, Roth IRAs, employer-sponsored retirement plans, cash-value life insurance, home equity and annuities.

Education savings accounts are considered assets. Because they are, it’s important to take into account the various features each offers in terms of ownership (parent, grandparent or child); contribution limit (fixed to unlimited); flexibility of usage (private k-12 tuition only, college, graduate school tuition and other qualified education expenses); and effects on financial aid calculations.

There are several types of education-savings accounts: custodial accounts commonly referred to as UMGAs and UTMAs, abbreviations for the Uniform Gift to Minors Act and Uniform Transfer to Minors Act, respectively; Coverdell Education Savings Accounts, and 529 College Savings Plans.

A synopsis of options

The Coverdell Education Savings Account (ESA) uses after-tax dollars and grows tax free, with no tax on distributions used for qualified education expenses. ESAs offer flexible investment choices similar to IRAs, yet have income restrictions and a contribution limit of $2,000 per year. Also, ESAs are irrevocable; once made contributions cannot be taken back. 

529 Accounts, like ESAs, use after-tax dollars and grow tax free with no tax on distributions used for qualified education expenses. Unlike ESAs, there is no annual contribution limit as long as the beneficiary’s account balance doesn’t exceed the total balance limit. However, keep in mind the $16,000 annual gift tax exclusion limit applies. Another important difference of note: when being considered in financial aid eligibility calculations, 529 accounts are weighted differently depending on the owner. 

Parents’ assets are assessed at a fraction of a child’s assets, 5.64% vs 20%, respectively. If the 529 account is owned by a grandparent, it is not considered a parent’s or child’s asset for Federal Application for Student Aid reporting purposes. However, when a distribution is made from the grandparent owned 529 account to pay for a grandchild’s qualified education expenses, it would be assessed as “student income” at 50% the following year. This influx of income significantly reduces the student’s eligibility for needs-based financial aid. Another differentiator: 529 accounts are portable. The beneficiary may be changed to another member of the beneficiary’s family.

UGMA and UTMA accounts are taxable investment accounts established to benefit a minor and be used for any purpose. Contributions are unlimited, however the annual $16,000 gift-tax exclusion applies. Unlike other education-savings options, when the child reaches the state-set age of majority (usually age 18 or 21), he or she assumes legal control of the UGMA or UTMA account and may use the assets for any purpose, including higher education. As with the 529 accounts, assets owned by a child will affect his or her ability to receive needs-based financial aid. In addition, UGMA and UTMA accounts are irrevocable.

We hope this newsletter has given you a snapshot of the options available and the highly personal considerations involved in selecting an education savings account. Suzanne Rismiller, your financial planning resource for The Poindexter Group, is ready to assist you. You may contact her at suzanne.rismiller@opco.com or call 713-650-2054.

RESOURCES

• Financial Aid and the Effects of 529s by Oppenheimer & Co. Inc.