Retirement and College Savings

Wondering how to balance out retirement planning along with college savings goals? We will cover that as well as account types for college savings here!

Balancing Retirement and College Savings Goals

First, lets talk about the balancing act that we all have to consider when it comes to these two lofty goals. The average retirement is now averaging 30+ years due to advances in medicine and longevity. At the same time, the average 4 year degree has a tuition of $129,000! So how do we make sense of funding both of these goals and what should be considered?

First, lets talk priorities:

Both retirement and college savings goals are very admirable, common goals. I advise considerate thought and conversations with both your family and financial professional. This will determine where your goals are prioritized.

I first want you to consider the ways these goals can be funded. College can be paid for with savings, grants, scholarships, current income (at time of enrollment), loans & student work. Retirement relies on your preparedness, benefits and planning.

I also discuss if paying for college is worth certain trade-offs?

  • Is becoming financially dependent on your children in retirement or not retiring at all a reasonable trade-off?
  • Would you have a willingness to work longer or save more to achieve these goals?
  • Is it your goal to fully fund college or to simply not leave the full burden of student debt on your child(ren)?
  • Are you willing to compromise on your retirement lifestyle for the purpose of paying for college?
  • Would downsizing your house or budget be considered to achieve both goals?
  • Is there any consideration to relocating to a more tax-friendly or lower cost of living state in retirement?

I have found that there is no universal answer to these questions. I say this because everyone’s priorities, values and goals are unique to them, and they should be! These are yours, and should be considered when we craft a customized plan!

My final considerations would be around the importance of having financial flexibility and what inheritance goals you have. These are real concerns that shouldn’t be overlooked. However, without a considerate conversation it can be possible to miss such topics. So be prepared. The previous points are a great starter for you!

Accounts For College Savings:

529 College Savings Plan

529 Plans are said date back as far as 1986 and originated at the state level as a method to fund college tuition costs (prepaid tuition programs). Since that time they have gained popularity as well as additional notoriety. The Small Business Job Protection Act of 1996 included the first publication of Sec. 529. Qualified State tuition programs. Although the plans take their name from Federal tax code, the plans are administered by the 50 states and District of Columbia.

Types of 529 Plans:

Savings Plans

529 college savings plans are the most common type of plan. The account holder (custodian) contributes money to the plan that can be invested in Mutual Funds. As the custodian of the account, you are able to choose what funds to invest in and the account performance will be determined by the gains or losses of the funds over time. Many plans will include target date or target allocation funds to simplify they process for investors as well.

Should your account grow over time the balance (including the growth of the portfolio) can be withdrawn tax-free if used for qualified expenses. Qualified expenses include Tuition, Fees, Room and Board, and Related Costs. For the purposes of illustration, if $70,000 is saved by contributions and grows to $110,000 all of the activity during the savings/growth is shielded from taxes (capital gains from re-balancing or fund distributions, dividends and interest). In a brokerage account these activities would create tax liabilities, including converting the investments to cash to spend. Due to the tax-free withdrawal of 529 funds for qualified expenses the $40,000 in gains ($110,000 value vs $70,000 cost basis) will go without being taxed.

Originally limited to only use for college, legislation in 2017 opened up use of 529 plans for K-12 education as well and the SECURE Act furthered the reach to Apprenticeship programs. In addition, up to $10,000 can be used for student loan repayment of the account beneficiary and their siblings. View your 529 plans contribution limits at the time of opening the account.

Prepaid Tuition Plans

These plans are offered by a limited number of states and some higher education institutions. Plans vary but the principle of them is to lock into current tuition rates through the plans for a student that will not be attending college for some years. Unlike savings plans these are only applicable to college and the plans should be reviewed for where they are acceptable.

In contrast, the savings plans are accepted at almost all universities and/or places of education opening more flexibility in choice.

Tax Advantages of 529 Plans

As previously mentioned, the growth and withdrawal of funds from 529 plans present tax advantages to investors when used for qualified educational expenses. Withdrawals not classified as Qualified Educational Expenses are subject to taxes and a 10% penalty.

In addition, certain states offer state tax deductions or credits for utilizing their plans if you are a resident of the state (no federal income tax deductions or credits are offered). Its important to note that you are not required to invest in your states plan, but should tax benefits exist it would require your investment as a resident into your states plan for your tax purposes.

Other Considerations

529 plans are transferable up to a first cousin basis of the beneficiary. Therefore, should you find that you have saved and your child does not pursue trade school, an apprenticeship, college or has left-over money it can be transferred for the benefit of other children in the family or to the benefit of the parents for qualified educational expenses. Also, 529 plans allow for a penalty-free withdrawal up to the amount of scholarship awards for the beneficiary. Therefore, the money doesn’t go to waste if a portion or all of the tuition is covered via scholarships.

529 plans are based in Mutual Fund investments and each plan differs in the fund providers/choices available. Also note: 529 plans only allow for 2 re-balances of the portfolio per year.

Coverdell Education Savings Accounts

Coverdell accounts once filled the void for pre-college tuition or educational expenses. However, with the changes to 529 legislation they are becoming far less common. These accounts have lower contribution limits ($2,000 currently) and income limitations apply as well. In addition, Coverdell accounts are surrendered to the beneficiary at the age of 18 whereas 529 plans continue to have custodial oversight.

Tax advantages

Coverdell accounts do not provide income tax benefits however they share the same tax-free distribution benefits as 529 plans for qualified educational expenses.

Other Considerations

Coverdell accounts allow for a larger investment choice than that of 529 plans. In addition, re-balancing is not restricted within these plans.

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