Saving For College, A House Or Both?
Parents universally want the best for their children. As soon as your child is born, you imagine different aspects of their childhood; the picture with Santa Claus, school plays, their first home run, eighth grade awards, drivers training, and their high school prom and graduation. Beyond that, the future is in their hands and you want to make sure they have the resources to graduate college, perhaps put a down payment on a house, buy a car, and / or get married. Giving them a leg up can also help reduce your own long term tax bite.
Choosing the proper savings vehicle is not that difficult. It really comes down to choosing between a 529 College Savings Plan and a Uniform Transfer to Minors Account (“UTMA”). While there is nothing to prevent you from choosing both, let me explain the differences:
• 529 Plans are designed specifically for education savings. These accounts are primarily utilized to pay for College tuition and living expenses but can be also be used for up to $10,000 each year in high school expenses. Contributions grow tax-free and withdrawals are tax-free if used for qualified education expenses.
• UTMA / UGMA Accounts are intended for broader gift-giving purposes than just education. Recently, UTMA accounts now, for all intents and purposes, have been merged with Uniform Gifts to Minors (“UGMA”) Accounts and while some states still contain some differences, these accounts essentially have the same provisions. These accounts can be used for education but your child beneficiary will control their assets at age 18 – 21, depending on the state.
Tax Advantages:
• 529 Plans: Contributions are not federally tax deductible but may be tax deductible in your state (check with your state's tax revenue authority). Earnings grow tax-free (both federal and state) and withdrawals are tax-free for qualified education expenses.
• UTMA Accounts: Earnings are taxed each year to the minor child, with a tax exemption from the first $2600 in earnings in 2024. Essentially, if your child earns 5% on their funds, you won’t pay any taxes on balances up to $52,000. However, earnings over $2600 per year (indexed) are taxed at the parent’s tax rate until the child turns age 19. After age 18, all taxes flow through to the minor.
Financial Aid Impact:
• 529 Plans: Considered a parental asset, typically has a smaller impact on financial aid eligibility compared to a UTMA/UTMA account.
• UTMA Accounts: Considered an asset of the child, which can potentially reduce their eligibility for financial aid.
Control And Ownership:
• 529 Plans: You typically retain control over the account (even after age 18 or 21) and can change beneficiaries (within family) if needed.
• UTMA Accounts: Once the minor reaches the age of majority (typically 18 or 21 depending on the state), they gain full control over the account and can use the funds for anything.
Investment Flexibility:
• 529 Plans: You may invest in a wide variety of investment options, though there are more restrictions than an UTMA account. Typically, parents invest in target benefit funds where the target date is when your child reaches age 19 or 20. Because of the potential tax at the parents rate if earnings exceed a certain amount, zero coupon bond funds may provide an investment opportunity after the 529 balance reaches $50,000.
• UTMA Accounts: Allow for a wider range of investment options, similar to a taxable brokerage account.
In summary, you should choose a 529 plan if your primary goal is saving for education (for one or several children) and you want to retain control over the funds past age 18 or 21. Choose the UTMA account if your child is not “school inclined” or if you do not want to be restricted to just using the funds for a college education.
If you’re unsure, do both!
Saving For Your Child’s Future
On the eve of my son’s college graduation, I was feeling very proud that he developed diligence and discipline necessary to graduate on time. My wife and I had planned for this moment and it was happening. The only thing left was to make sure his mortarboard didn’t display some embarrassing quote that I would have to explain away for years. (Fortunately, he didn’t wear a mortarboard; choosing instead to don his school’s baseball cap with the tassel attached from that button on top.) Time had compressed so much in just a short time but a little dedication and probably some help from his friends was about to produce a walk across a stage, isolated hoots and hollers from the crowd, and a diploma. Don’t trip now!
It seems like yesterday when we took this little child with perfectly smooth skin home from the hospital. Initially, my son didn’t need me and I was frustrated until I realized that I lacked the necessary equipment to satisfy his basic needs. Oh, I could change the diaper and rock him to sleep but my son really didn’t care about me. I was just a conduit until he could suck the life out of his mother. I couldn’t blame him of course but the monotony of changing his diaper had worn off. I wanted more. This kid wouldn’t even smile for me unless it was gas. Here I am, responsible for his future, and he’s already an ungrateful teenager. Finally, about when he turned 3 months, I lightly tickled his belly and for the first time ever, he smiled at me! It wasn’t ear to ear but I know it was a smile. I was full of myself but then about a minute later, I could hear a grunt like he was already practicing for his teenage years, when the telltale rear end emission occurred and my short lived happiness was dashed. No smile, just poop. Back to the bassinette! I tossed the soiled diaper into that baby powder smelling diaper pail, lifted his legs up and placed a new diaper, the second to last diaper in the last box of diapers that we had received from the baby shower, under his smooth bottom. Before I could fold the flap over his frontside, my son decided that he had to singlehandedly put out a fire… on the ceiling… and on the dresser… and on the lamp… and on my shirt. I attempted to tether his hose but that just sprayed the little guy and after Niagara Falls had been emptied, I looked his chin dampened face and… nothing. Not a smile over what he had done. Just a poker face. Nothing to see here except pee drippings from the ceiling. Ho hum. “Hey, big guy, can you put another diaper on? I’m feeling a draft.” I cleaned him off as best I could, put him in his crib, then cleaned the room as best I could and realized that we had run out of diapers.
Realizing that I could be exposing the remainder of the house to flood damage, I raced to the store for a new supply and was hit with the shock of paying $20 for about 50 diapers! Holy literal Crap, these were expensive! Then it hit me. Kids are expensive! First diapers, then Little League, a broken arm, then college and then…. aah gee. College!
Let's Talk About School Saving
College costs were overwhelming. As I climbed into bed, the cost of raising this child had me contemplating a budget, something that I had always planned on but never achieved. Now I was worrying about his college? What about a wedding? Do parents have to pay for sons’ weddings or is that still a dowry thing? My mind was adding up the commas. I needed a second job. How much do child models make? (Not much!) Do they still have indentured servitude? How am I going to get this kid through college?
Somehow I managed to sleep but woke in the morning without answers. I began explaining the prior night’s event to my wife and she didn’t flinch. Now I knew where the kid got his stone face. Finally, she deadpanned, “I knew something happened. There was dried yellow spots on the baseboards, on the bassinette, in a lot of places. After feeding him, I looked around the room and I just figured that you both were drinking last night.” She then broke into laughter and teased me with, “I can just imagine you…” and “How did he get it on the lamp?”
I then stated that we need to start saving for his college education and my wife interrupted by saying, “I’ve already set up a savings account for him. We’ve got $600 in his account. We should probably look into a 529 plan.”
At that moment, last night’s worries vanished and I knew we would be okay. A few weeks later, we sat down and planned his future, first by analyzing tuition costs and using a future value calculator. Here’s what we did:
I set out to compute the annual amount of contributions needed to meet a four year college experience for our precious daughter. Now when I was computing potential costs, I was looking at college tuition rates back in the early 2000’s and estimating funds needed in 2020. But I’ll do it for you as of 2024 and 2041 so as not to confuse you.
Colleges and universities are divided into four types of tuition: Private, In State Public, Out of state Public, and Junior College. There are also trade schools which provide concentrated courses on auto maintenance, computer technology, home construction, HVAC repair, Cosmetology, etc.
I looked at several different websites that compare college tuition costs and fortunately, all of them were pretty close so I have referenced www.collegetuitioncompare.com.
I understand that it is somewhat difficult to determine the amount of tuition for a 1 year old but let’s try to help you out.
First of all, many parents are comfortable with having their child go to their own alma mater. The school was good for you so it will be good for them. If you and your spouse went to UCLA and University of Illinois, then a public university is probably a tuition range you should consider. If one of you went to a private liberal arts school, then might want to bump up your potential college savings goal.
Therefore, beginning soon after birth, you should set up a savings program through a 529 Plan or UGMA account for that ultimate goal. 529 Plans and UGMA’s are explained in a separate article.
