Financing and Saving for Your Child’s Education

For the majority of new parents’ education funding is a high priority. Anyone who has been saddled with college debt certainly does not want that for their own children. On the other hand, a responsible parent also needs to save for retirement, to buy a home, to financially protect their family and to build an emergency fund – and all today.

So, how can you set your priorities? What comes first? What comes last?

Couples can often disagree about how high on the priority list education funding ought to be. For example, maybe one parent simply worked his or her way through school, took out loans or won scholarships, whereas, the other partner’s parents were able to foot the bill, and now they’d like to do the same. If you are one of these couples, don’t despair. A few guidelines apply, though it is up to you and your advisor to make the final decision.

First, saving for college is no use at all if it throws you and your partner into long-term penury. If you need help from your children during your own retirement, you can make it impossible for your grandchildren to get a great education, because your adult-children will be too busy taking care of you.

Typically, college students can work through school, borrow money at reasonable rates, win scholarships and obtain grants. In retirement, you can do none of these things. So, the most critical step in the process is making sure you have enough in your budget to save. It’s a bit like the inflatable masks on an airplane. You place your own on first, then your children’s, because it is no good if you are passed out in the aisle.

Does this mean you should not prioritize education – of course not! Many tax-advantaged savings plans today will pay for high school as well as college costs. Grandparents, aunts, uncles and friends can also contribute to your child’s savings plan.

Most people use a mix of alternatives to fund education costs. As long as you qualify, you may wish to use several different plans. Here are the most popular options:

529 Plan

Earnings on investments in a 529 Plan may be used tax-free for high school and higher education, including college and graduate school. You receive no Federal tax deductions for what you invest, but you pay no taxes while you earn returns and no taxes on withdrawals for qualified education costs. If 529 Plan the funds are used for anything but allowable education costs, however, taxes and penalties may apply. You can own and control your child’s 529 plan. If your child does not use the funds, you may also switch the name of the beneficiary to a sibling or other family member.

Coverdell Education Savings Account

Any individual whose modified adjusted gross income is under the set limit for a given tax year can contribute. In 2018, that limit is $110,000 for an individual and $220,000 for a couple filing together. Like a 529 plan, you receive no deduction for contributions but funds can be withdrawn tax free for qualified education costs, including elementary school, high school and college. Withdrawals for other than education may incur taxes and penalties, so you should check with an advisor to see if a Coverdell is right for you. You can control a Coverdell account until your child is age 30, then your child controls the account and can use the funds as he or she wishes. The maximum anyone can contribute for one child in any given year is $2,000, so this plan is usually used in conjunction with other options.

Life insurance with a savings plan

While the main purpose of life insurance is to provide death benefits to your family, you may opt to use cash accumulation in cash value life insurance to fund all or a part of your child’s education. Funds in a whole life policy accumulate on a tax-deferred basis and you may also access your funds without penalties or taxes. Monies withdrawn will reduce your death benefit so this process must be managed by a professional to be sure your coverage stays intact. You may insure yourself or your child, locking in their excellent health and protecting their families in the longer-term. Limits on amounts do apply and all insurers are not equal. You should look for a strong mutual company that provides safety, financial security and durable returns.

Taxable investment account

You can always save for education in an individual taxable account using stocks, bonds, ETFs, mutual funds and etc.. The pros to this approach are that funds are completely flexible and may be withdrawn at any time for any reason. Taxes do, however, apply. You may also wish to have a professional help manage your funds, so you are not subject to significant market volatility as you approach the time your child needs the money.

UTMA or UGMA

These are trust accounts, not limited to education that you may set up with your child as beneficiary. While there are no income tax advantages, apart from a slight advantage as a portion of the funds may be taxed at your child’s lower tax rate, these trusts move funds outside your estate. The funds are controlled by a designated trustee and must be used for the benefit of your child, until your child reaches age of majority, 18 or 21 in most states. At that time, your child controls the funds. UTMAs and UGMAs are a commonly used estate planning technique. Gifts to an UTMA or UGMA are irrevocable and permanent, i.e. you cannot take the funds back for your own use. There is no limit on what you may contribute to an UTMA or UGMA though gift taxes may apply.

Every family’s situation is unique and each technique has advantages and disadvantages, so please check with a Certified Financial Planner ™ as to which options may be right for you and your child.