College is a major expense, and families without a plan for their children risk jeopardizing their retirement and future financial independence. Many financial advisors discuss college savings as part of a family’s overall financial plan. New parents, parents of high school students and grandparents all turn to financial advisors for help with college planning.
Here are expert tips from financial advisors on how to help clients solve three common issues with college planning.
Case 1: New parents without a plan to save for college
Jamie Malone, Principal and Financial Strategist at Agili, a fee-only Registered Investment Advisor (RIA) in Richmond, Virginia, helps his clients find the right balance between saving for their own financial future and their kids’ education. He advises young parents to open a 529 plan as soon as possible and contribute consistently.
“Starting to save early can yield big results due to compound interest,” he says. “Let’s say the parents of Jackson (age 13) and Ava (newborn) decide it’s time to put some money away for college. They save $200 per month for each child for 5 years ($12,000 each) and earn 6% annually. When Jackson turns 18, he will have nearly $14,000. Not bad, his college funds earned almost $2,000. What about Ava? Like Jackson, $12,000 was saved, but Ava’s college funds will benefit from an additional 13 years of growth. By letting time and compound interest work together, Ava’s funds earned over $17,500 allowing her to have almost $30,000 when she heads off to college.”
Andrew Schwartz, Senior Vice President and Financial Advisor at Madison Planning in White Plains, New York, also advises clients to start saving early.
“Parents with children under the age of 10 have the potential advantage of time on their sides,” he says. “They can dollar-cost average a set amount into a 529 plan and get tax-sheltered growth.”
By contributing a set amount each month, parents can mitigate investment risk. Over 18 years, the average cost per share in a 529 plan will represent both the premium prices in a bull market and the discounted prices of a bear market.
Jeff Motske, President and CEO of Trilogy Financial in Huntington Beach, CA, notes that in his experience, younger parents are more eager to start saving for college.
“It’s never too early to start putting a plan in place for college,” he says. “529 plans are usually a good place to start, because they have low minimums.”
Motske starts the college savings discussion during his first meeting with clients. “If you don’t bring it up it sneaks up on you, and can really hurt what you're trying to do with other financial goals.” he says.
Case 2: Late starters
Malone recommends parents of high school students develop a savings plan, but he takes a different approach with 529 plans than he does with younger parents. When you have a shorter time horizon to invest, he suggests choosing a more conservative 529 plan investment option. This enables parents to take advantage of any available state income tax benefits without too much risk. Over 30 states offer an income tax deduction or credit for 529 plan contributions.
“Even if college is approaching, we might still use a 529 for tax purposes,” he says. “You could get a state tax benefit by contributing, but we’re less concerned about growth and more focused on making sure the money is there for upcoming college expenses.”
Schwartz reminds his clients that even if they haven’t planned for college, all is not lost. He recommends looking for financial aid to bring down costs.
“They can appeal to the college and explain their circumstances in detail, apply for grants and consider other choices like a loan and/or work-study,” he says.
Families can also bring college costs down by having the student take AP classes in high school or start out at a community college. Students who start out at a community college can still graduate with a degree from a 4-year college, but at a fraction of the cost of attending all four years.
Motske has had clients who spent enormous amount of money on out-of-state colleges and their child walked away with a large amount of debt and no degree. He suggests having a conversation with your child before their junior year of high school about what they see as their future path. For example, students pursuing a medical degree will likely be able to afford their student loan payments.
“Don’t set your kids up to have student loan debt with no clear plan to pay it down,” he says.
Case 3: Grandparents and 529 plan account ownership
When saving for a grandchild, Malone generally recommends keeping the 529 plan account in the grandparent’s name. He is aware of a situation where a grandparent made contributions to a parent-owned 529 plan, only to have the parent withdraw the funds for a purpose other than college.
“If it’s money you want to have control of, make sure the account is in your own name,” he says.
Another option for grandparents who are concerned about spendthrift parents is to contribute to a custodial 529 plan account owned by the grandchild, but with the grandparent as the custodian. This lets the grandparent retain control over the account.
Schwartz also notes potential advantages to having a grandparent-owned 529 plan, including estate planning benefits and state income tax benefits. Most states allow anyone who contributes to a 529 plan to claim a state income tax benefit, however in 10 states only the 529 plan account owner is eligible to claim the income tax benefit.
Motske advises grandparents to keep funds in their 529 plan account until it’s time to pay for the grandchild’s last two years of college. Distributions from a grandparent-owned 529 plan taken before January 1 of the student’s sophomore year of college (assuming the student will graduate in four years) will count as cash support on the Free Application for Federal Student Aid and reduce the student’s eligibility for need-based financial aid.