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Published: February 12, 2008
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EmailAs a financial planner, Larry Golub often tells his clients that the most important step in saving for college is a simple one: start early. As a parent, he made sure to follow that advice.
When Golub’s wife, Gretchen, was still pregnant with their first child, now 2-year-old Maxx, he opened an educational savings account called a 529 plan. The couple hopes the quick start will leave them with enough money to cover most, if not all, of Maxx’s expenses whether he chooses a local public university or a pricey private college far from home.
“This may be a bit extreme, but early, early, early is key,” said Golub, an advisor at Gore & Golub, LLC in
The best way to fight that panic, financial advisors say, is to get organized as quickly as possible. Once parents explore their options for saving, they see that while they may not be able to sock away hundreds of dollars each month, a little at a time – say, $10 that would have gone for another toy or a couple hundred for a big birthday party – can add up to a significant amount. That’s especially true if parents, grandparents or other family members take action before a child is ready for any kind of school, said Debra Ianucci, a financial advisor with Ianucci Insurance & Financial Services in
“Starting when a child is a newborn is a lot less cumbersome than even when they’re 3 or 5,” Ianucci said. “It really drives down what you have to set aside each month.” That said, parents who get a later start shouldn’t despair, said Mary Morris, executive director of the Virginia College Savings Plan. The state program has four investment options to help families in many different circumstances and with a wide range of goals, Morris said. Even if a child is already in high school, it’s not too late to get some benefit through certain plans. And if parents can’t save enough to cover all of a child’s college expenses, whatever they can manage will help make a chosen school affordable, Morris added. “That view can be less intimidating to someone who has the idea that college is simply out of reach,” she said.
With help from Golub, Ianucci and Morris, here’s a basic guide to five of the most common ways a family can invest in education:
1. 529 qualified tuition plans
These plans offer tax advantages to encourage families to save for college. Contributions are tax-free and currently eligible for up to $2,000 of state income tax deductions per beneficiary per year for
- The Virginia Prepaid Education Program (VPEP): This state-run plan allows families to lock into today’s tuition and fees at in-state public colleges and universities for newborns through ninth graders. In other words, costs won’t go up even if they increase at those colleges over the years (which they almost certainly will; prices have jumped about 11 percent over the past five years). During VPEP’s enrollment periods, parents can arrange for a one-time contribution, monthly payments or, if a child is younger than an eighth-grader, a five-year payment plan. VPEP also includes more affordable one-year community college plans. Families tend to pay more upfront than with other state plans, but they know exactly what they’ll have covered – and get a great deal –should a child go to a public school in Virginia. However, parents should understand that while benefits may be applied toward the cost of an in-state private school or a college outside Virginia, they may not get full credit for money deposited, Ianucci said. Also, VPEP accounts are designed to cover tuition and fees only, not additional costs such as room and board and textbooks.
- The Virginia Education Savings Trust (VEST): This program is an individual savings account sold by the state. Money is invested in a parent’s choice of 16 portfolios of stocks and bonds. VEST plans have no state residency requirements and generally can be used for a wider range of educational expenses than VPEP money. Enrollment runs year-round. Parents can open an account with as little as a $25 application fee and a $25 contribution, Morris said.
- CollegeAmerica. This is the Virginia College Savings Plan’s partnership with the American Funds, a large national mutual fund company. Families work with their own financial advisor to choose from more than 20 funds and save tax-free for tuition, fees, room and board, books and other supplies. For information, call 1-800-421-4120 or go to www.AmericanFunds.com.
- CollegeWealth. This is Virginia’s newest 529 plan, a partnership with more than 50 financial institutions across the state. Participating banks work with families to create savings accounts and Certificates of Deposits, or CDs. CollegeWealth may appeal to more cautious investors who aren’t as comfortable dealing with mutual funds. Since there are so many variables by plan – and within each plan – depending on family situations, the best approach is to study all options and weigh the pros and cons, Morris said. For help, go to www.virginia529.com or call a free line at 1-888-567-0540.
2. Coverdell accounts
Previously known as Education IRAs, these accounts are trusts created to pay education expenses. Contributions are not tax-deductible, but they and their earnings can be withdrawn tax-free if the money goes to eligible education costs. Currently, families also can use the money to pay for primary and secondary school expenses.Families generally can contribute up to $2,000 a child per year – a cap not found on 529 plans – with greater flexibility in terms of investment options compared to 529s. But parents should be aware that children gain full control of the money when they reach “majority age,” which in Virginia is when they turn 18 or, if they’re still in high school at 18, when they graduate. Also, if children don’t use the money by age 30, taxes and penalties will apply.
3. Individual savings accounts
Parents can open taxable accounts to save money for college. They are able to keep control over assets and have flexible investment options, and they can use the money for another purpose without tax implications if a child doesn’t go to college. Some people also open brokerage accounts within their savings plans and buy individual stocks and bonds. Unlike money in a 529 plan, however, the earnings are subject to income or capital gains taxes. That means the after-tax return on the investment may be lower.
4. Custodial accountsThese are accounts established at a financial institution and managed by a parent or other guardian. A potential downside: Custodial accounts may lower the amount of financial aid a child can receive because they’re considered assets of the child rather than of the parent. Like Coverdell accounts, children gain full control at majority age.
5. IRAs
Parents can withdraw funds from their retirement accounts for educational expenses without a penalty (although taxes may still be due on the withdrawal). However, that interrupts the tax-free growth that makes Roth and traditional IRAs particularly valuable as retirement options. That, in turn, could increase the risk of becoming a financial burden on a child later in life.The best way for parents to start choosing a strategy, Golub said, is to have a “philosophical” talk about what they’d like to provide for a child. That should happen before they meet with a financial advisor, tax expert or lawyer or self-research any plans. For example, parents who want to be sure they can pay 100 percent of tuition at an elite private school may need to invest differently than those who think children should be responsible for covering part of tuition. Parents who think the odds are good a child will go to a public university in Virginia may be ideal fits for the pre-paid tuition program, Golub said. Families who have help from a grandparent or other relative may have smaller monthly savings goals than those who don’t.
Parents also need to decide how college planning should fit into their family’s overall financial picture. Is it more important to save for retirement or college? Is spending money on children when they’re younger – taking great vacations or enrolling in lots of classes and camps, for example – equally important for their “life experience” than college? “I find the more clearly you define the goals, the more likely you are to stick with your plan,” said Golub, who chose a CollegeAmerica account for Maxx. A good financial advisor, he added, won’t recommend any products or plans before getting information about a family’s situation.
Whatever path they choose, parents should see saving for college as an investment, financial advisors say. Overall, the average college graduate earns $23,000 more a year compared to people with a high school diploma alone, according to data from the U.S. Census Bureau. Students who have to rely heavily on loans to pay for college also may have to put off major life steps such as getting married, having children or buying a home. Plenty of today’s graduates find themselves in that situation: According to a 2006 study by the College Board, undergraduates rely on loans to cover 52 percent of college costs; financial aid and scholarships cover less than 45 percent.Of course, children also can help save money by getting a job in high school, aggressively researching scholarships, grants and financial aid opportunities (go to www.fafsa.ed.gov to learn more about applying for federal aid) and taking classes at a community college before transferring into a four-year program. Once a child is in college, parents should be sure to check with a financial advisor about tax credits they can claim. Grandparents also should be aware that paying for a grandchild’s schooling may be tax deductible for estate taxes, making it a helpful way to pass on family money. “The idea that families think college is just out of reach for them – that is a concern for me,” said Morris, whose daughter recently graduated from the College of William and Mary with help from a VEST account. “There’s so much emphasis on how hard it is to save. My message is that it can be manageable, as long as you think about it and save a little bit over a long time. It will add up – it really will.”
Some online resources
Financial planners, tax specialists and lawyers all can help a family sort through college savings options. There also are a number of online sites with information and answers to frequently asked questions:
