College Savings Plan 101—It’s Never Too Early To Start

February 2015 View more

37192262_thumbnail_800pxChildhood has been described as long nights and short years, and it’s true. These kids are babies one day, and suddenly “semi-adults” and ready for college (or for whatever next steps they choose) the next day. Because time flies, it’s never too early to start a savings account for college expenses.

A Plan of Attack

For 2013-2014, college costs averaged $23,000 annually for in-state public institutions and $45,000 for private institutions. With college costs increasing an average of 6 percent annually, today’s newborn will require about $300,000 and nearly twice that amount for a private university.

Andy Saeger, vice president and senior financial consultant for Charles Schwab Naperville, encourages clients to run the numbers to determine what the cost of college will be for their children, but says parents shouldn’t let the figures overwhelm them. “While college costs may be steep, saving for college is like saving for retirement,” Saeger said. “A good first step is to determine a realistic monthly savings goal and set up automatic monthly payments.” The web features many college savings calculators to help you determine how much you can save over time.

Savings Plans

If you’re new to college savings, know that there are tax-free qualified college savings plans for use in paying college tuition, books, supplies, and room and board that offer growth on your investment. The 529 plan is a state-sponsored program that allows parents, or others, to invest for a child’s college education. Saeger says there’s no limit to how much a person can contribute each year, but there is a lifetime maximum that varies by state. In Illinois, that’s $350,000 per beneficiary. Also in Illinois, an individual can contribute up to $10,000 per year, $20,000 for a married couple filing jointly, and costs are deductible in computing Illinois taxable income.

While contributions are subject to gift tax rules, which generally require that any annual contribution over $14,000 ($28,000 per couple) to a single beneficiary be reported on a tax return, Saeger says there’s also a special gift tax exclusion. An individual can contribute a lump sum of up to $70,000 ($140,000 per couple) to a 529 plan “This is treated as a five-year gift, so any gifts beyond this amount to the same beneficiary during the five years would be subject to the gift tax.”

The Coverdell Education Savings Account (ESA) is another tax-advantaged account option, with an annual contribution limit of $2,000, plus income limits for opening this kind of account. You can have both a 529 plan and an ESA if you wish.

Risk Tolerance

Whatever plan you choose, your goals and risk tolerance are important factors. For younger children, investing aggressively can potentially result in better returns over time. Saeger says one such investment option is an age-based portfolio that invests more aggressively when the child is young and automatically shifts to a more conservative asset allocation as college age approaches.

Financial aid formulas consider 20 percent of assets held in a child’s name available for college expenses, but 529 plans and ESA’s are considered the parents’ asset where only 5.6 percent of the money is considered available for college expenses. Grandparents opening a 529 plan would likely not factor into initial financial aid eligibility. However, once a beneficiary begins withdrawing from the 529 plan created by grandparents, the distribution will be considered the student’s income and could potentially impact financial aid in subsequent years.

Financial experts say college planning should be part of a larger financial plan, which includes planning for retirement. Experts strongly discourage parents from dipping into their retirement fund to pay for college expenses.