Saving For a Child's College
June 21, 2017 | Marshall Weintraub, CFP, and Michael Merrill, CFP, CLU, ChFC
Saving for a child's higher education often gets put on hold as physicians and their families go through their final years of training. Paying off credit cards, replenishing emergency reserves, and home purchases are common priorities shortly after household incomes increase. Once the dust has settled, one of the next questions parents reflect on becomes, "how do we plan for our children's education?" This article will review educational cost and inflation trends before turning to 529 plans.
Cost of Undergraduate Attendance
We know how much college costs today but are unsure of what higher education will cost when children attend or what preparation is needed until then. According to the College Board, average tuition and fees for a year of undergraduate education for the 2016 2017 academic year were $9,650 at public colleges and universities for in-state students, $24,930 for public out-of-state students and $33,480 at private institutions. These are in 2017 dollars, so we need to consider education inflation rates. Over the past decade, public education tuition has risen 3.5 percent annually over general inflation (which was about 1.8 percent per year).1,2 This means the cost of tuition will have grown from $9,650 to $24,448 after being inflated at 5.3 percent for eighteen years for a child born today if this inflation rate continues. The fourth year tuition will be $28,545 for a total tuition cost of $105,843. Additional costs of attendance, such as food, room and board, and books, averaged $15,000 per year. All in, preparing for a child's undergraduate experience can require several hundred dollars to be saved each month.
Fortunately, you have a tax-advantaged option with 529 plans. These qualified tuition plans are state-sponsored accounts usually established with the child as the beneficiary and an adult as the account owner. This is commonly a parent, but can be another adult. Contributions to 529 plans do not receive a federal tax deduction, though some states allow a state income tax deduction for in-state residents up to a certain amount. Maximum contribution limits vary by state and are quite high, such as $250,000 to $400,000. With that said, contributions are classified as gifts, so donors usually limit annual contributions to $14,000 per beneficiary. Otherwise the excess amount is a taxable gift and filing a gift tax return is required. Donors can also choose to make an accelerated gift of up to the next five years' worth of gifts in a single year, amounting to $70,000 per donor or $140,000 per married couple.
Contributions are invested in mutual funds and grow tax-deferred to hopefully outpace tuition inflation. Investment options typically include age-based funds, which are usually comprised of underlying mutual funds and managed to be more aggressive when your child is younger with a long-time horizon until college. They become more conservative as your student approaches high school graduation due to a shorter time horizon. When the funds are needed, they can be withdrawn from the 529 plan tax-free if used for qualified education expenses, including tuition, books, room and board, or a computer. However, if a distribution is taken from a 529 and not applied toward qualified expenses, then the earnings above the amount contributed are taxed as income and charged a 10 percent penalty. An exception applies to this penalty if your child receives a scholarship. You are allowed to withdraw the amount of the scholarship received from the 529 and avoid paying the penalty, though investment earnings distributed will still be taxed as income.
Parents want to give their children the best possible opportunity for success in the adult world. For many, particularly doctors and their spouses, this means providing financial support through your children's undergraduate education so they can begin a promising career or go on to graduate school without a large student loan burden. As you prepare for this, be sure to balance this with your own planning, as most doctors have some catch-up to do with their retirement saving after many years of training.
This article was authored by Marshall Weintraub, CFP® and Michael Merrill, CFP®, CLU®, ChFC®
2. U.S. Bureau of Labor Statistics. Databases, Tables & Calculators by Subject. Consumer Price Index - All Urban Consumers, U.S. Bureau of Labor Statistics, 20 Feb. 2017, https://data.bls.gov/timeseries/CUUR0000SA0?output_view=pct_12mths. Web. 20 Feb. 2017.