College Planning Options

As you probably know, college is expensive.  As you may not know, college costs are rising faster than inflation and almost no one is predicting that college costs are going to go down.  As a result, you may want to start thinking about funding your children’s college costs now.  The sooner you start thinking (and hopefully saving) the easier it will be. 

College Costs Today

According to the College Board, the annual costs (tuition, room, board, books, supplies, transportation, and other) of attending college for 2023-24 were about: 

• Four-year private college - $56,190
• Four-year public college for an in-state resident - $24,030
• Four-year public college for an out-of-state resident - $41,610  

While many students qualify for scholarships and other forms of financial aid to bring these numbers down, you may also want to consider some of the other costs (travel, entertainment) that may add to these numbers. 

Funding College Educations

For decades, parents have used custodial accounts to transfer funds to their children to help build assets for college costs.  However, the 2001 tax law has enhanced the tax benefits of other types of asset ownership that should be considered.  Coverdell Education Savings Accounts (Education IRAs) and Qualified Tuition Programs (Section 529 Plans) have become very attractive. 

Custodial Accounts

Using a Uniform Gifts to Minors Act (UGMA) or Uniform Transfer to Minor Act (UTMA) account is an easy and legal way to transfer the ownership of assets to a child.  With a UGMA or UTMA account, the parent creates a custodial account on behalf of their child.  Assets are transferred into the account and the custodian (usually a parent) manages the account until the child reaches legal age. At that point, the child can do whatever he or she wishes with the assets. 

Transfers to these accounts are irrevocable. 

Coverdell Education Savings Accounts (Education IRAs)

Coverdell Education Savings Accounts provide parents and others the opportunity to save for a child’s education expenses in a tax advantaged account.  The annual contribution limit is $2000 for these accounts.  There are also income limits for those making the contributions.  

Earnings within the account are tax deferred and withdrawals are not subject to tax if they are used for qualified education expenses.  The new law expanded this definition to include expenses for elementary and high school expenses.  Withdrawals not used for qualified education expenses are subject to regular income tax and a 10% penalty.  Withdrawals must also be completed before the child reaches age 30. 

Education IRA accounts function like IRA accounts and are available from most banks, credit unions, brokerage firms and mutual fund companies.  Investment options vary depending on the firm.  Usually there is considerable flexibility with self-directed type accounts. 

Qualified Tuition (Section 529) Plans

These college savings plans are now offered by most states and were also enhanced by the 2001 tax law.  While the plans are offered by the state, there is no restriction on where the child attends college utilizing the funds.  One potential drawback is that there are usually limited investment options.  It makes sense to look at several states’ programs to find one that offers the investment choices you desire. 

With a Section 529 Plan, there are no income limits on the donors and contributions of up to $18,000 can generally be made without incurring a gift tax.  In addition, there are special provisions to allow a “front-end loading” of up to five years of contributions to be made without gift taxes, also called superfunding.  Withdrawals used for qualified educational purposes are excluded from federal income taxation.  

The Value of Starting Early

It can be easy to delay saving for college, especially if your children are young. However, by starting early, even with a small amount, you can make a significant impact on your future financial obligations. You can always increase your contributions as your income grows, but time can be your ally.

Savings Accumulation Table

Chart is for estimation purposes only; assumes earning 5% and no income taxes.

Some Conclusions

Enabling your children to attend the college of their choice and receive an education that will prepare them for a successful and productive life is one of the greatest gifts you can give. However, the costs of providing that college education can be significant. Starting earlier rather than later can make the process much easier, especially with some of the tax benefits offered by Coverdell Education Savings Accounts and Section 529 Plans. Be sure to consult with a trusted tax and financial advisor for more information. Developing a college savings habit can provide your children with the funds they need and give you peace of mind knowing that your child’s future is in good hands.