It’s beginning to “cost” a lot like Christmas!

 

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It’s beginning to “cost” a lot like Christmas! It’s a fun play on the popular holiday song, “It’s beginning to look a lot like Christmas”, originally written by Meredith Wilson in 1951. Though times have certainly changed since the 1950s, the spirit of gifting and giving during the holidays has always remained the same. According to the National Retail Federation, the average American spends an average of $1,000 during the holiday season!

It’s not uncommon, as we approach the holiday season, that you might find yourself feeling grateful, compassionate and more charitable than any other time of the year. Now is the time people eagerly give to their loved ones and generously give back to those in need. Here’s a look into new and exciting ways people are giving and gifting in 2018:

529 College Savings Plans

As the total student loan debt in the U.S. approaches the $1.5 trillion mark, 529 college saving plans have grown in popularity. Unlike ordinary gift checks, a 529 savings plan can an act as an investment in a child’s future that has the ability to grow, tax-free, for the use of qualified educational expenses (K-12 tuition included under the new tax law). While college savings may not be the most riveting gift for a young child to receive at the time, the potential to alleviate the future burden of student loans, all or in part, will be one gift they won’t soon forget.

Custodial Investment Accounts

There are two main forms of custodial investment accounts, UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfers to Minors Act) accounts. They are virtually identical aside from the ability of UTMA accounts to hold real estate. Custodial accounts can be a great way to teach children about investments while limiting their access to investment funds. Depending on your state, access to custodial accounts is limited to minors until the child has obtained ages 18-21.

In 2018, individual gifts are limited to the annual $15,000 gift-tax-exemption limit ($30,000 for married couples). Family and friends can contribute directly to custodial accounts of another person. If these accounts are properly titled as retirement accounts, such as a Custodial Roth Account, contributions must be made indirectly, limited to $5,500 for 2018, and the donee must have earned an income equal to or greater than the contribution made.

Charitable Gifts

Did you know you can complete charitable gifts in the name of a friend or family member and still capture the tax deduction? Assuming you itemize, funds given to charity can come from any taxable account (or qualified, see below) of your choosing and may list a donor of your choosing. For example, one can give to St. Judes Children’s Hospital using their own personal funds, receive a tax deduction for doing so, and list the donor as someone other than themselves, like a grandson or other relative. So long as you can prove the funds used came from you, i.e. your name is listed on the account used, you should receive a deduction for these forms of charitable contributions.

There are several ways to give back to charity, one of the more tax efficient ways is by way of Qualified Charitable Distributions (QCDs). This is an alternative to Required Minimum Distributions (RMDs) that you are required to take from your IRA upon obtaining age 70 1/2. A QCD allows you to give a portion or all of the amount that you otherwise would be required to take from your IRA to charity. The benefit of doing so is to exclude these funds from your taxable income. This process can be especially beneficial if, under the new tax reform, you will be using the new increased standard deduction, $12,000 for individuals and $24,000 for married filing jointly, as opposed to itemizing.

There are many forms of giving. Integrating both charitable giving and family giving can be an intricate part of your overall plan, and it doesn’t always have to “cost you an arm and a leg.” Ensuring your gestures are both sustainable and tax-efficient are good questions to ask. At DWM we are always looking for new ways to give back to our clients and friends by assisting in these areas. Please, never hesitate to reach out to us in regards to new ways to give back to your family, friends and charitable organizations.

Emptying the Nest

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It is an exciting time of year when smiling faces in caps and gowns are seen everywhere! Recently having the pleasure to witness my son’s graduation, the President of the University of South Carolina made sure that the graduates took the time to thank their parents for helping them get to this important occasion. Absolutely! So, congratulations, parents! Turning 21 or graduating from college are exciting milestones and your kids have now reached what we all consider to be the beginning of “adulthood” as they get ready to enter the “real” world. Kids grow up in all different ways and in all different stages – is your young adult ready for launch?

At DWM, we like to offer proactive financial advice for all members of our clients’ families. As your young adult is readying to depart the nest, however that looks, we think this is a good opportunity to provide some education, as they take the reins of their own financial future. Many college-aged kids have had a student checking account and understand how to use their debit card pretty well by now! They probably have some experience with having a job and budgeting for things they want to buy in the short term. However, some of the more complex financial topics can be intimidating for young adults, While they may have a solid background in finance, it is always good to review concepts like compound interest, building good credit, taxes, buying insurance and understanding 401(k)s, for once they land that first “real” job! We might suggest that a good place to start is by getting a copy of The Wall Street Journal. Guide to Starting Your Financial Life by Karen Blumenthal (https://www.amazon.com/Street-Journal-Guide-Starting-Financial/dp/030740708X ). This book covers issues about renting or buying your first home, basic investing, taxes, purchasing health insurance, buying a car, establishing good credit and saving for retirement, among other topics. Might make a perfect college graduation or 21st birthday gift!

In addition, this is a good time to help them make sure all of their accounts are properly set up, titled appropriately and that they have a savings program in place. Reaching the age of majority, which is age 21 for both Illinois and South Carolina, is a good time to change any custodial accounts like a UTMA and UGMA to individual accounts. It may also be helpful to talk about debt, perhaps review student loans and consider opening a credit card account to establish some credit history. Using debt wisely, having a good emergency fund and responsible budgeting are all really valuable conversations and will help your young adult navigate their new financial map.

Encouraging saving and investing is a fundamental lesson and the “pay yourself first” concept is an important one. Remind them that they are paying their future self and that, just like the rewards for eating right, exercising and wearing sunscreen, saving and investing will benefit the health of their future self (as well as their current self!).

One idea that might help is having an automatic savings app like the one found in The College Investor article https://thecollegeinvestor.com/17610/top-automatic-savings-apps/. Also from The College Investor, you can find numerous financial and investing podcasts available that your young adult may take interest in. Here’s the link to get started: https://thecollegeinvestor.com/6778/top-investing-podcasts/. Or maybe they would want a subscription that focuses on the economy, like The Economist or Wall Street Journal.

If working and the business offers it, they should always make sure to contribute to their 401(k) to get the most advantage of any company match. And, if they don’t already have one, starting a Roth account is another great investment savings vehicle, especially while their starting incomes and lower tax brackets will allow them the opportunity to make annual contributions. Up to $5,500 of their earned income can be directly contributed to a Roth account and the compounded gains will never be taxed. Your young adult can set up automatic transfers to investment accounts or savings vehicles so they get used to not seeing those funds in their everyday account, just like 401(k) contributions. It is a great way to plant the seeds for a successful future!

Once the young adult has gotten some traction and they have good financial habits in motion, encourage them to contact us and check out the Emerging Investors program at DWM http://www.dwmgmt.com/investors/. You can learn even more about the EI program by clicking on this link and accessing one of our recent blogs written by Jake Rickord http://dwmgmt.com/archives-blog/index.php/2017/11/. Our Emerging Investors program offers a specialized financial planning model with DWM investment strategies that uses the automated Schwab IIP platform. Our goal is to help them graduate to full DWM Total Wealth Management clients down the road. The best way to reach the level of a TWM client is not just by higher earning, but by stronger and earlier investing. We love to educate and help others plan for their financial future. We are always available if you or your young adult have any questions and would certainly welcome feedback.   Please let us know how we can be of assistance!

 

College Funding Solutions

Last night, our Palatine team at DWM performed a presentation for the parents of students attending Quest Academy, a private K-12 school right here in Palatine, IL. The focus of the night was putting a spotlight on two important topics, tax reform and college savings. We’ve covered the effects of tax reform quite a bit in blogs from the past few weeks, so we wanted to focus in on the savings portion of the presentation for our blog this week.

College costs are rising, with no end in sight. Tuition prices for public and private universities increase yearly by approximately 4-8% consistently, which put them right up there with housing and gas prices as the leaders of inflation (though college costs experience much less volatility then either of the others). Per Figure 1, we can see the effect of this inflation, with tuition at an in-state public university costing parents over $100,000 over the four years of collegiate study. With inflation rates as they are, these numbers are only going to get larger.

Tuition

Figure 1: College Tuition Costs

So, as we presented last night, how can parents of children expect to be able to pay these high price tags?

Luckily, there are several different options available to parents and children alike that can help offset the huge costs of college. These different solutions vary from federal financial aid, merit-based scholarships, savings, and loans.

Let’s start with federal financial aid. The path to being awarded federal financial aid starts at the same spot for each family, the Free Application for Federal Student Aid, commonly referred to as the FAFSA form. This document helps many domestic colleges determine how much, if any, federal aid your child should be allotted. To determine this, the FAFSA form interprets your financial situation based on their calculated Expected Family Contribution (EFC), or essentially how much money the parents of a student will be able to contribute to their child’s college tuition. To determine the EFC amount, many factors including the family’s taxed and untaxed income, assets, and benefits (such as unemployment or social security) are evaluated. Retirement assets are not considered in this calculation. For example, any money held in an IRA or 401k plan will not be counted towards the EFC, since those funds cannot be used for college tuition. However, money held in a checking or brokerage account will factor into the EFC when calculating federal financial aid. One important caveat to this is that any funds held in the student’s name will be weighted more heavily towards the EFC calculation than those assets held in the parent’s name. For a quick reference, please see Figure 2 below, which gives an approximate federal aid allotment based upon your EFC and the number of children you have.

EFC

Figure 2: https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/troyonink/2017/01/08/2017-guide-to-college-financial-aid-the-fafsa-and-css-profile

Another college funding solution is the use of merit-based scholarships, which are awarded by the schools themselves, based on a student’s academic, athletic, music, or other merits. If a student shows exceptional talents, colleges are likely to offer these students grants in order to entice them to coming to their college. These scholarships tend to be offered for at least four years of college depending on their eligibility, and can often be a hefty sum of the tuition costs (some being the full amount)! Besides the colleges themselves offering these scholarships, there are various online sources that have private funding that is given out to students who apply to them. We have done some research on these websites, and have included some of the most popular ones at the bottom of this blog. Please feel free to check them out with your student!

One of the major college funding methods that students and their parents utilize is through savings. Besides holding assets in a bank or brokerage account to pay for their child, parents have some other ways of saving money specifically for college funding that can be great resources also for tax purposes! One of the best of these vehicles is a 529 plan. In Illinois, we like the Illinois Bright Start and Bright Directions 529 platforms, and in South Carolina, our team likes the Future Scholar 529 platform. What these programs offer is a method for holding college funds and investing them, allowing for compounding tax-free growth! By contributing to these accounts, taxpayers can annually take advantage of a $10,000 state tax deduction ($20,000 for married couples) for Illinois, and can utilize the $15,000 dollar gift tax exclusion on the transfer as well, helping to lower the taxes for the parents, and save a lot of money for their child quickly. In comparison, South Carolina offers an unlimited state deduction for all contributions to a 529 plan. In conjunction with this, in all states parents are able to take advantage of a “Five-Year Forward” funding method, which allows for up to $150,000 to be contributed to a 529 plan in one year, and as long as no extra contributions are made in the following four years, the entire amount qualifies for five years of the gift-tax exclusion, a fantastic strategy for savings and estate planning, for parents and grand-parents alike! As part of the recent tax reform, the government has expanded the use of these plans to allow parents to use these funds to pay for K-12 private schooling, though this could prohibit the use of the state tax deduction, which is still a grey area. Stay alert for more updates on this particular change.

Lastly, there are loans. Most students and parents have come to a modern consensus that student loans are extremely hard to pay off, and as of 2018, student loan debt does indeed sit at approximately $1.5 trillion, so whenever loans are taken, it is extremely important that parents take into account how these will be paid off. There are many different options when it comes to taking these loans as well, including federal versus private loans (government vs. banks), and deferral timings (“subsidized” start payments once graduated, “unsubsidized” start payments immediately). Some important aspects of loans to look at when researching them is to ensure that they have no application fee, a soft hit on credit pulls, and no fees for paying off loans early, so you get out with the least interest accrued as possible.

All in all, paying for college is a daunting task for any parent and student. However, by planning early and utilizing the many different methods of funding, both can find peace of mind and focus on the challenges presented in reaching a higher education, and less on how they are going to pay for it.

If you have any questions on any of the above information, please do not hesitate to reach out!

Scholarship resources to check out:

bigfuture.org
cappex.com
fastweb.com

Now’s the time to plan your 529!

Summmerrrtttime!  Every day in the summer at our office here in Charleston, we are regaled with the carriage tour drivers’ versions of this famous song from Porgy & Bess.  We end up having that song stuck in our head a lot of the time!  Already the ads for back to school sales are appearing and it reminds us that, while the “livin’ is easy” right now, the hustle of getting kids ready to head back to school isn’t far away.  We hate to interrupt your summer fun, but it is a good idea to get ready for college tuition payments no matter what age those students are!

We wanted to highlight the particular advantages of using 529 plans for funding your education purposes, as it is the most cost-effective way to manage the expenses of higher education.  Enacted in 1996, Section 529 of the Internal Revenue Service Code allows an account owner to establish a plan to pay for a beneficiary’s qualified higher education expenses using two types of plans – a pre-paid tuition program or the more popular, state-administered college savings plan.  The beneficiary can be a family member or friend or an owner can set up a 529 account for their own benefit.  Anyone can then donate to the account, regardless of the owner or beneficiary.  Funds can be deposited and used almost immediately (need to wait 10 days) or can be invested and grown until needed.  Surprisingly, according to a Wall Street Journal article recently, only 14% of Americans plan to use 529s to pay for college.

Although there is no allowable federal tax deduction for 529 contributions, the income and gain in the account are not taxable, as long as they are used for qualified education expenses.  These qualified expenses include tuition, room & board, books and, in a 2015 legislative change, payments for many technological expenses like a computer, printer or internet access, even if not specifically required by the educational institution.  The costs for off-campus housing can also qualify, as long as the amount used matches the average cost of resident-living at your university.  Many states, like SC and IL, also allow a tax deduction for 529 contributions to in-state plans.  Another recent legislative change allows for an increase from one to two annual investment selection changes per year, unless there is a rollover and then a change can be made at that time.  This gives the 529 owner a little more benefit, flexibility and control over their accounts.

When funding 529 accounts, we recommend that our clients not fund more than 50% of the total cost of estimated expenses for the education of their student before the student selects and starts college.  One nice feature about 529 plans is that they are transferrable to a sibling or other close family member, if a student doesn’t use or exhaust their entire 529 account.    However, you don’t want to overfund an account and then have some leftover.  Only the gains in the account are taxed, but there is a 10% penalty on the account if the funds are withdrawn and not used for qualified education expenses.  Another reason for not overfunding is that there are many scholarships available – you may have an accomplished science whiz or an amazing athlete that earns scholarship money.  Once final amounts of tuition requirements are determined, 529 account owners can make necessary additional contributions to take advantage of tax benefits.

There are many scholarship opportunities available for those who take the time to look and apply.  Checking with the high school guidance counselor, local civic groups or community organizations about scholarships or awards opportunities can give your high school student some hands on involvement in paying for their own education!  All high school seniors should also fill out the annual FAFSA (Free Application for Federal Student Aid).  There are many opportunities for earning money for college and nothing should be ruled out.

We know that using 529 accounts is the least expensive way to pay for college.  Research shows that the most expensive way to pay is by taking out student loans or paying out of pocket as the student needs it.  At DWM, we want to help you strategize how to save for and pay for any education expenses that you may have before you, no matter when those costs are expected.  We can help you evaluate the various state plans and the investment options in the 529s and calculate an appropriate annual or lump sum amount of savings.  We will be glad to help make your summertime livin’ easy and carefree!  Okay, now back to summer fun…already in progress!

Have You Saved Enough For Your (Grand)Child’s College Expenses?

 

anatomy of piggy bankHappy May 29th – a few days past – otherwise known as 529 day. According to the College Board’s “Trends in College Pricing” report, the cost of attending a four-year university rose roughly 3.5% from 2015 to 2016. Costs just keep going up. Have you done enough educational planning for Junior? Take a breath of fresh air and then check out how much college will cost at these schools for the upcoming 2016-2017 school year:

Average Cost of College 2016 2017 final

For those of you with younger ones or planning for a family, fortunately, there is still time! Read on as this blog is for you as it focuses on what may be the best college savings program out there: 529 College Savings Plans!

The 529 is a great opportunity for parents, grandparents, or other family members looking to help a child make college a reality someday. Studies show that children with money set aside for college are seven times more likely to actually go there.

529 Plans are state-sponsored investment programs that qualify for special tax treatment under section 529 of the Internal Revenue Code. These plans typically involve an agreement between a state government and one or more asset management companies. The contributor (e.g. parent, grandparent, etc.) of the account typically becomes the account owner and the account owner controls withdrawals of assets. The person for whom the plan is set up becomes the beneficiary (e.g. Junior).

Tax-Free Growth.  Earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college. The 529 account remains under the control of the account owner rather than transferring to the child at the age of majority as in the case of an UTMA/UGMA. Any U.S. citizen can participate in a 529 and the funds can be used at any accredited college or university.

Quality investment options.  Most 529 programs have a couple dozen quality equity and fixed income investment choices to choose from. Most programs will also allow you to choose an age-based asset allocation model which makes the underlying portfolio become more conservative as the beneficiary approaches college age. Or you create your own portfolio to match your risk tolerance (whether it be more conservative or aggressive) and expected timing of funds. A wealth manager like DWM can help you decide.

Contribution limits.  Unlike other tax-advantaged vehicles, 529 have no income limitations on who can contribute, making them available to virtually anyone. Contribution limits to 529 are determined by each 529-sponsoring program independently, but most are quite attractive with limits over $300,000 per beneficiary. To reach that total, a married couple can contribute as much as $140,000 within a single year (the limit is $70,000 for individuals) and, as long as no more is contributed in the following four years, the entire amount qualifies for five years of the gift-tax exclusion. (This type of 5year “front running” can be a great estate planning strategy for grandparents as well.)

Tax benefits.  There is no federal tax deductions or credits for 529s, but there typically is at the state level. Contributions to a 529 are fully deductible in South Carolina and up to $10,000 per year by an individual, and up to $20,000 per year by a married couple filing jointly in Illinois assuming you use an in-state program – Bright Start & Bright Directions in Illinois & Future Scholar in SC are all excellent choices. Contributions remain tax-free if used for qualified education expenses.

What’s a Qualified Education Expense?

-Tuition

-Required books, equipment, supplies

-Computer technology

-Room and board for ½+ time student

-Special needs expenses of a special needs beneficiary

Non-Qualified Withdrawals. Non-qualified withdrawals will not get the special tax treatment. With a few exceptions, such as when the beneficiary receives a scholarship, the earnings portion of non-qualified withdrawals will incur federal income tax as well as a 10% penalty.

Effect on Financial Aid. A 529 account is counted as an asset of parent if the owner is the parent or dependent student. This is typically more beneficial than other vehicles when calculating the expected family contribution figure.

What happens if the beneficiary decides not to attend college?

The tax laws make it easy on the family if the beneficiary for some reason doesn’t go to college or use the 529 earmarked funds. The account owner can simply change the beneficiary by “rolling over” the account to a “family member” of the original beneficiary with no penalty whatsoever. The definition of “family member” includes a beneficiary’s spouse, children, brothers, sisters, first cousins, nephews and nieces and any spouse of such persons; but typically and most logically it’s one of the original beneficiary’s siblings. Or the account owner can use the funds themselves – it’s always fun to go back to school and learn! Or the least likely option is “cash out and pay”, where the account owner can redeem assets for himself/herself as a non-qualified withdrawal and pay ordinary income taxes and a 10% penalty.

529s vs other college savings plans. Downsides of the others:

  • UTMA/UGMA: 1) Control/custodianship within an UTMA/UGMA terminates at age of majority (21 in Illinois & 18 in South Carolina), and 2) kiddie tax considerations and capital gain considerations upon liquidation
  • Coverdell Education Savings Accounts (“ESAs”) – maximum investment is only $2,000 per beneficiary per year combined from all sources within ESAs whereas 529s are typically $300K+ per beneficiary.

Conclusion. There is over $230 Billion in 529s now up from less than $10B in 2001. The reason for this growth is people catching on to what really is a great tax-free funding vehicle for an important future educational need. Prepare for that financial burden today by saving early and saving often with a 529 account. Give us a call to help get you started or talk more about educational planning in general.

Tax Tip: Choosing the Right College Savings Plan

529This time of year, everyone is looking to find ways to avoid large tax burdens. Contributions to your child or grandchild for college savings may be a great way to plan for the future and get some tax relief right away. As a college savings tool, 529 plans are the most popular choice to maximize tax-free growth of your investment, as long as it is used entirely for qualified secondary educational expenses. An individual can contribute up to $70,000 and a couple up to $140,000 to one beneficiary in a single year, as long as they count it towards their annual gift tax exclusion over a five year period. Many of the 529 plans allow for maximum account values of over $300,000. The 529 contributions are considered an asset of the custodian, allowing for flexible financial aid qualification for the student and transfers of the funds between accounts for other beneficiaries. Each state has its own plan and investment module and many offer tax benefits for contributions by residents. If your state does not offer tax incentives, then you are free to invest in any of the top-performing 529’s in other states, as most plans do not have residency requirements to participate. DWM can help find the best direct-sold plans with low operating expenses and good allocation menus. South Carolina’s direct sold plan ranks in the top 10 and Illinois in the top 15 for the last 5 years and both offer tax incentives for residents.

Before the 529’s were created, the investment choice for many was the Uniform Gift to Minor Acts (UGMA) or Uniform Transfer to Minors Act (UTMA) custodial accounts. These plans offer the advantage of allowing for non-qualified educational expenses without penalty. For example, if you want to use the funds to buy a car for your teenager. The UGMA/UTMA accounts also offer a full range of investment options with the ability to choose allocations and make changes as you would with any other investment account. There is also no limit on the maximum contribution amount. UGMA/UTMA accounts are taxed on their growth and mandated by the rules of the “kiddie tax”. This tax provision allows for the first $1,000 of unearned income of the minor to be tax-exempt and then the second $1,000 is taxed at the young account holder’s lower tax rate. Any gains from investment growth, dividends or interest above that $2,000 unearned income limit will be taxed at their parent’s higher tax rate. This tax provision affects all account holders under 19 or dependent full-time students between ages 19-23.

So what happens if you are the custodian for a UGMA/UTMA for a minor child or grandchild and you want to move it to a 529? 529’s can only accept cash deposits so the account will have to be liquidated and the custodianship terminated. The irrevocable provisions of the beneficiary arrangement in Uniform Minor acounts, however, must still be maintained, even in the 529. The 529 will ask for the source of the funds, and, if coming from a UGMA/UTMA, some 529 plans will register it as a Custodian 529. This simply means that the beneficiary rules designate the account holder be given control of the asset at age 18. The same Uniform Minor laws apply regardless of what kind of account these funds transfer to because the original asset was in an irrevocable account. Funds cannot be transferred or used by siblings or other family members without a penalty.

Is it prudent to move the funds into a tax-exempt 529? The biggest consideration are the taxes created by the liquidation of the UGMA/UTMA account and/or the annual taxes owed by the minor during its operation. After evaluating the potential gains to be made during the life of the account, you must consider what the tax on those gains will be. You can choose to liquidate the account in pieces over time or all at once, depending on the tax burden created. The tax must be paid at some point, so perhaps sooner rather than later will prevent it from increasing. Another choice is to leave the assets where they are and put any additional contributions in a new 529 for the beneficiary. This will avoid causing a taxable event while creating a beneficial 529 account. There may be a tax benefit to transferring the funds into a state-sponsored 529 plan because of tax breaks offered by some states, like South Carolina and Illinois. The tax owed on the gains may be offset by the tax incentives offered. You will have to weigh the implications of the long-term tax-saving benefit of transferring into a 529 against the tax burden created by liquidating the account.

While it’s true that the 529 is an excellent college-saving tool, there can be advantages to using the Uniform Minor accounts as well. And a conversion of a UGMA/UTMA account to a 529 can be a complex decision. At Detterbeck Wealth Management, we can help you evaluate your situation to determine the best option.

College Savings 101

college savings

The college acceptance letters have been tucked away and it is a time of senior-itis, prom nights, and graduation celebrations. Spring of senior year in high school is an exhilarating and anxious time for students and their families preparing for the transition to college. Now come the nuts and bolts of paying for it… have you set your student up well for this next phase? There are some strategic decisions that can and should be made to make sure your high school senior (and your family) have more excitement and exhilaration and less anxiety when the time comes!

Currently, the most popular and arguably the most appealing college-savings options are the state-sponsored 529 plans. According to the College Savings Plans Network (CSPN), the popularity of these funds has steadily grown and increased the last decade’s assets by upwards of $100 billion. 529s offer Federal and usually state tax benefits through tax-free investment earnings on accounts ultimately used for qualified education expenses. They allow (and encourage) parents, grandparents, and relatives to participate in the student’s future. And, 529s will not usually affect financial aid status. Another plus is that the unused assets of 529s can transfer to another family member for qualified costs. Each state offers unique versions of these federally tax-exempt plans that generally fall into three categories: direct-investment, advisor-sold, and pre-paid or guaranteed funds.

The direct-investment options offer the greatest flexibility and choice with lower fees and typically no commissions. Regardless of your residency, most state plans are available to all. However, there may be additional tax benefits by using your state plan, as in South Carolina, where you can deduct contributions from your state taxable income and save 7% tax on each dollar spent. Some states, like Illinois, cap their allowable state benefit. Investment menus of plans include either passive (index) funds, actively managed funds or both. Historically, the passive funds have outperformed. Furthermore, funds can be allocated on an age-based option or, what we prefer, a target allocation option, reviewed and rebalanced over time. The ceilings for maximum contributions on direct investment accounts range from $235,000 to $450,000, which can then cover the costs of all tuition, room and board, books, travel, etc.

Guaranteed or pre-paid options are designed to have contributions keep up with the increasing costs of tuition. If you contribute an amount equal to a year’s tuition today, the student will get credit for a full year of tuition when he or she enters school, regardless of the then current cost. Hence, the pre-paid options do protect your investment from any market volatility, but have lower maximums and less flexibility. The advisor-sold 529 plans are also less flexible in investment strategy and pack on higher fees for commissions and management costs. 

Other college-savings methods can be a Uniform Gift to a Minor or Trustee (UGMA/UTMA) which are not tax-exempt after the $14,000 gift tax exclusion and also will transfer to the beneficiary at the age of majority. However, these assets have much greater investment flexibility and the first $1,000 of annual earnings (2013 and 2014 limits) are not taxed to the student. Other regular investment accounts provide greater investment flexibility, but earnings are taxed at the owner’s rates. Straight savings options are out there in the form of bonds or an education IRA (Coverdell Education Savings Account), which are tax-exempt for qualified education costs.

There are many options worth reviewing to prepare for the ever-increasing costs of tuition. Some models predict that education costs will more than double over the next 15 years. Starting the process early and putting together a plan with the right mix of contributions, investment selections and tax benefits will help ensure that your student’s high school graduation someday will be all celebration and very little worry about paying for higher education. It will be here sooner than you think!