The rising cost of a college education
For many of us, a child’s college education is the largest single expenditure in our yearly budget. College education costs are staggering — rising at levels far surpassing inflation — with the 2020-21 average tuition and fees for full-time students ranging from $10,560 for in-state public universities to $37,650 for private institutions.1 Of course, that doesn’t take into account room and board or graduate school.
Whether you are the parent of an infant or a teenager, by considering your options now, you can get a head start on saving for your child’s future. While no investment strategy is right for everyone, there are several approaches geared specifically toward education saving.
Investing to manage the tax bite
A 529 plan allows parents and relatives to invest in a child’s college education fund using after-tax contributions that grow tax free. A 529 plan is controlled by the account owner and can be a prepaid tuition plan or the more common education savings plan, which is typically invested in a selection of mutual fund-like investments. Normally the beneficiary of an education savings plan may be changed to another qualified member of the beneficiary’s family and may provide the ability to move from one state’s plan to another,2 although there may be state tax consequences in doing so. There is no annual limit for 529 plan contributions, but many states limit total contributions per beneficiary. Withdrawals from both plan types are federally income tax free when used for qualified college expenses; an education savings plan may also be used for qualified K-12 expenses.3 However, earnings not used for education expenses are subject to taxes and a 10% penalty. A state income tax deduction may be available to residents in some states as an incentive to use that state’s plan. 529 plans vary between states, so be sure to check with your tax advisor for your situation.
A Coverdell Education Savings Account (Coverdell ESA), is an account designed to help pay for a child’s education. The education account grows free of taxes, and withdrawals are tax free if used for qualified education expenses, both college and K-12. The annual contribution is capped at $2,000 per beneficiary. There is a prorating of the $2,000 contribution depending on a taxpayer’s adjusted gross income (Married Filing Jointly: $190,000-$220,000; Single: $95,000-$110,000). Funds not used for qualified education expenses or not withdrawn by the time the beneficiary reaches his or her 30th birthday are subject to taxes and penalties.
Next steps
There is a variety of investment choices available for saving for a child’s education, and those choices are dependent on the account type, your risk tolerance, and timeline. A financial professional can work with you to review your savings options and determine the best strategy for your unique situation. D.A. Davidson offers a number of financial calculators online, including one specifically for the cost of education.
Just remember: the years go by quickly, and before you know it, that new baby will have its own dreams for the future. Your planning today may make those dreams a reality for tomorrow.
1 Trends in College Pricing and Student Aid 2020 Report
2Depending on your state of residence, there may be an in-state plan that provides state tax and other state benefits. Before investing in any state’s 529 plan, investors should consult a tax advisor.
3Not all states have accepted K-12 expenses as qualified. Homeschooling is not included. Distributions of $10,000 per student each year is federal tax free. At the state level, many states will need to take legislative action to enable the expansion of 529 qualified distributions and, if applicable, state tax incentives. Otherwise, the 529 withdrawal for K-12 tuition may be considered a non-qualified distribution subject to state tax recapture of any state income tax deduction previously taken. Consult with your tax advisor before making a withdrawal for K-12 tuition or before making a contribution intended to be used for K-12 tuition. Also, contact the 529 plan provider, review the plan provider’s website and read the plan’s disclosure statements for announcements related to this issue. Prepaid tuition programs normally pay for college tuition costs only, though a plan may agree to cover room and board as well.
D.A. Davidson & Co. is a registered broker-dealer and registered investment adviser that does not provide tax or legal advice. The information contained herein is believed to be reliable, however; we can make no guarantee as to its accuracy or completeness. Any opinions expressed are based on our interpretation of the data available to us at the time of the original article. These opinions are subject to change at any time without notice. Copyright D.A. Davidson & Co., 2021. All rights reserved. Member SIPC.
Please see the Municipal Securities Rulemaking Board’s (MSRB) Investor’s Guide to 529 Savings Plans for detailed information.
529 Plans and Coverdell ESAs may impact eligibility for financial aid and other loan programs. Investors should carefully consider these impacts before making a decision.