By Teresa Kuhn, JD. RFC, CSA
Living Wealthy Financial
College tuition rates are increasing at a breathtaking pace
leaving many American parents tossing and turning at night wondering how, or
if, they’ll be able to pay for college when the time comes.
Adding to this worry is the very real possibility that a decision
of where to park college funds might turn out to be more important than
standardized tests, grades, or extracurricular activities in determining a child’s
ability to attend a college of their choice.
In fact, more and more parents have
realized that, next to retirement planning, college planning is one of the most
vexing, yet critical components in a family’s healthy financial future. That’s why most parents are willing to
undertake arduous, often frustrating steps to learn more about the choices they
have when it comes to solid educational planning.
There are, of course, several acceptable methods of planning
for a child’s higher education, including 529 plans, Uniform
Gift to Minors Accounts (UGMA), Uniform Trust to Minors Accounts (UTMA), Coverdell
Education Savings Accounts, and of course, ordinary savings and investment vehicles. Each of these, as you probably suspect, each
has its’ own advantages and disadvantages as well as its’ own unique rules and
requirements.
Let’s take a look at one of the most
popular ways people are currently choosing to plan for their child’s education,
the 529 plan, and see how the pros and cons line up to help you determine
whether or not this is a good choice for your child.
I’ll also explain a little-known way that,
even if you have one of these plans and it seems to be working well, you can
improve it and add to your peace of mind.
What IS a 529 Plan Anyway?
“529” refers to the section of the Internal Revenue Code
that describes a government-administered savings plan that is designed to be a
tax-advantaged way for people to save for qualified higher education expenses.
Such plans are usually sponsored by individual states and
are regulated by state agencies under professional management. Qualified
withdrawals are now free of federal tax and depending on the state in which you
live; you can save in excess of $200,000 per beneficiary.
While there are several advantages of 529 plans that make
them attractive to parents, they also have certain non-negotiable requirements
that could, depending on your individual circumstances, become problematic for
you when the time comes for your child to use them.
For example, although 529’s have generally fewer
restrictions on distributions and offer a place to shelter funds when financial
aid is being calculated, they often offer few to no state tax incentives.
Another critical issue with 529 plans is the stipulation that funds may only
be used for qualified educational expenses such as tuition, books, and room and
board.Should your child decide to not attend college, if he or she receives a full scholarship, or if your child wants to attend an unaccredited school, you are usually forced to either transfer the 529 funds to another beneficiary or withdraw them.
If you don’t have another qualified beneficiary, you can pull out the funds, subject to tax penalties. These penalties could be substantial. If you have been able to take state tax deductions, for example, you may wind up getting a bill for back taxes as well as a 10 percent penalty on earnings.
Because 529 plans are administered by the individual states,
they vary substantially in quality. An analysis of state plans published by Saving
for College.com (http://www.savingforcollege.com/articles/2014-plan-performance-rankings-q1)
ranked New Jersey, District of Columbia, and California as
having the best performing plans in 2014, based on an array of criteria over 3,
5 and 10 year periods.
According to Saving for College.com, New
York , Alaska , and Utah were the three
worst-performers. Parents living in
low-performing states might want to look into other alternatives to finance
their children’s’ education.
Like most investment funds, the typical 529 savings plans charges a percentage of your investment to cover operating costs. These fees vary from state to state and also depend on whether you purchase your plan directly from your state or buy it through a broker.
Citing a report by Financial Research Corporation, Forbes magazine points out the typical 529 plan offered through a state has an average annual fee of 0.69%. A 529 sold through a broker has an average annual fee of 1.17%.
Explains Forbes, “Although the difference may seem negligible at first, it adds up. If you invested $10,000 over 18 years (assuming you’d get a 6% return), you could have $2,000 less in a 529 plan with a 1.17% fee, compared to a plan that charges 0.69%.”
(http://www.forbes.com/sites/learnvest/2013/07/18/529-savings-plans-9-mistakes-people-often-make/)
Risk and reward?
Because they are tied to the market, earnings in a 529 plan
are uncapped.
However this ability to earn without limit is tempered by
the inevitable amount of risk associated with investments tied to Wall Street.
While promotional materials and brokers often tout the “risk-free”
nature of 529’s, the fact is that many states do not guarantee their plans,
including Illinois, Kentucky, Maryland, Michigan, Nevada, Pennsylvania, South
Carolina, Virginia and West Virginia.
In certain states, you may have no commitment that your
money will cover the cost of a college education if tuition hikes outpace your
investments.
Fewer choices
Depending on the state in which you live, investment options
within 529 plans can be limited. In some
states, you have only one investment option.
A blended, balanced approach to college planning
Just as there is no “one size fits all” blueprint for
retirement planning, there is also no one college planning vehicle that is
perfect for everyone. Each family has
its’ own resources, challenges, and unique circumstances.
This is why I recommend that, regardless of whether or not
you have one of the qualified government plans, you consider the power of a
Bank on Yourself® plan to help you meet or exceed your college planning goals.
Here are just a few ways having a Bank on Yourself plan as
either the cornerstone of your college planning or as a supplement to existing
plans makes sense:
- Flexibility. 529 distributions must be for "qualified education expenses”. The cash you put into the specially-designed whole life policies like the ones used in Bank on Yourself plans can be used for anything. So, if junior decides to skip college and become an entrepreneur, your BOY policy could be used as seed money to help him realize his dream.
- No impact on financial aid calculations. Unlike other savings vehicles, money you put into a Bank on Yourself policy is not used in determining eligibility for financial aid.
- Liquidity. If you need
to, you can borrow from your Bank on Yourself policy and then pay yourself
back. You get the interest,
instead of a bank. If
circumstances ever forced you to skip a Bank on Yourself payment, your
credit would not be impacted.
- Safe, sane growth. Since Bank on Yourself plans aren’t tied to the stock market, your money isn’t exposed to the risky business on Wall Street. BOY offers safety and predictability. When you borrow from a Bank on Yourself policy, your money will continue to grow… as if you had never taken out a cent!
- Tax advantages- When you have a professionally-tailored Bank on Yourself plan, your money is generally tax-free. In fact, if you ever have to borrow from the policy, you will pay no fees, penalties, or taxes on that money.
- No limits on how much you
can contribute. Bank on
Yourself policies can be structured so that you can retain their
advantages regardless of how much money you want to contribute.
- Additional peace of mind with the death benefit.
- Control. With most qualified plans,
allocation changes can only be done a specific number of times and dates
on an annual basis. Having money in
a Bank on Yourself plan allows you to remove funds when you come across
other attractive investment opportunities. For example, instead of paying
college dorm or apartment expenses, if you had enough in your Bank on
Yourself policy you could purchase a house or income-producing property
where your child could live while they earned their degree.
- Fewer limitations: Most Bank on Yourself BOY plans can be
structured to exceed the limits of a 529 plans, and they are not subject
to the $350,000 lifetime limit of a 529 plan.
- Beneficiary options: In a 529 plan, investors can change plan beneficiaries without penalty, at any time, and for any reason. However, 529 plans have family beneficiary restrictions. A customized Bank on Yourself plan allows the owner to change the beneficiary to any person, or to a charity, as well as to choose multiple beneficiaries to receive whatever percentage deemed appropriate by the policy owner.
These
are just a few of the reasons why I recommend that my clients consider adding
the power of a well-designed Bank on Yourself plan to their college plans. Having Bank on Yourself in addition to
anything you already have in place is a great way to plug holes in your plan
and create a more predictable path to college planning success.
You
can learn more about how you can tap into the amazing potential of Bank on
Yourself by going to the Living Wealthy Financial site at http://www.livingwealthyfinacial.com,
or by calling us at 1-800-382-0830
