College Financial Planning

Wealth advisors recommend younger clients start saving for college early – even if it's a small amount.  You can save for your child's college costs tax-free.  Many families put aside money from their paychecks for their child’s future college costs.  College experts recommend parents start saving early and regularly through automatic deductions every month.

Whether or not you’ve already started saving, you should know that there are special savings accounts that can benefit you: 529 college savings plans and Coverdell Education Savings Accounts (ESA). 

Let’s look at these in more detail:

Benefits of a 529 plan: 

• Assets grow free from federal and, in many cases, state taxes, if withdrawals are used to pay qualified education expenses.
  
  
• You (the account owner) control the account and how the money is spent.
  
  
• Anyone can contribute to help reach the educational goal. This means that additional family members and non-relatives can contribute as well. A contribution to a 529 plan makes a great birthday or holiday gift.

There are many different 529 plans, and each plan features different investment options. So it's a good idea to research which plan fits the needs of your family.   

This is where working with an experienced financial advisor can help, both in choosing the right type of plan, but also in making changes over the years to maximize the opportunity for growth.

The earnings from your 529 savings plan aren’t subject to federal tax, neither while they’re in the account, or when you withdraw them either, as long as the funds are used for qualified education expenses. 

In addition, depending on your state’s tax regulations, you may be able to deduct some or all of your contributions.

Further, 529 accounts provide flexibility. You can transfer the account to another family member — as long as the new beneficiary is related to the original beneficiary.

So, if your first child gets a scholarship and doesn't need all of the funds in his/her account, you can change the beneficiary to another child to be used for his education goals. 

Or you can use the money for yourself to get that next degree. You can even choose to hold on to it for a future grandchild.

Usually the account owner is the parent or grandparent, and the beneficiary is a minor.  The account owner maintains and controls the account, making all the decisions about taking withdrawals and changing beneficiaries, for instance, as well as selecting investments. 

So you, as the owner, have the final say about how and when the money will be used.  

Here  are some final things to know about a 529 savings plan:

• There are no income limits.  That means whether your income goes up or down over the years, it doesn’t affect 529 eligibility.
  
  
• Any U.S. citizen or resident alien with a valid social security number or taxpayer ID and who is at least 18 years old, can open a 529 savings plan.
  
  
• There are no age limits on beneficiaries.  You can do it for a child, grandchild, peer, someone older than you, or even yourself.

Then what is the difference? The biggest difference between an ESA and a 529 savings plan has to do with the way you invest the money, in other words, the investment options. With an ESA, you can choose almost any kind of option—stocks, bonds, mutual funds. You can't do that with a 529 plan. You can also change the investments to different places any time you want (also not an option with a 529).

Here are some more ESA differences:

• In a 529, money must be used by the beneficiary by age 30 or given to another family member to avoid taxes and penalties.
  
  
• Both can be used for primary and secondary school, not just college expenses, up to $10,000 per year (a change from the tax act of 2017)
  
  
• An ESA has income restrictions. The ability to contribute phases out for incomes between $95,000 and $110,000 (single filers) and between $190,000 and $220,000 (married filing jointly).
  
  
• Contributions are limited to $2,000 per child, per year.  This is a potential limiting factor if you are looking to add more than this yearly.

However, distributions from a cash-value life insurance policy must be reported as taxable income or untaxed income to the beneficiary on the subsequent year's FAFSA. And since a FAFSA must be filed every year to qualify for financial aid, this does make a difference.

Investing in Life Insurance to pay for college

Here’s how permanent life insurance works as a college savings tactic: For every dollar you pay in premiums, a portion goes towards the death benefit and another portion is diverted to a separate cash-value account. 

From an investment perspective, whole life insurance is generally the safest version. The issuer credits your account by a guaranteed amount, although it may pay more if the investments perform well. Most policyholders can expect a return of anywhere from 3% to 6% after the first several years.

Other types of coverage, such as variable life insurance, give policyholders a degree of control over their investment. In this case, you select the sub-accounts – essentially mutual funds – that you want to be attached to your policy, and your account’s annual return is pegged to the performance of these underlying investments. The potential reward is greater, but there’s a risk that your balance could fall in a given year if the market takes a plunge.

When it’s time for your son or daughter to start college, you can take out a loan against your cash balance. The insurer will reduce your death benefit if you don’t pay back the loan, but that’s not necessarily a drawback for those who intended the policy primarily as a college savings plan.

In most cases, the principal portions of these loans are tax-free.

It can take 10 years or more for your cash value to surpass what you paid in premiums. So unless you buy a policy before your kids are in kindergarten, it’s hard to make a case for life insurance as a way to build up your assets.

On top of that, heavy annual expenses continue to weigh down your earnings. Most permanent life policies charge upwards of 2% per year in administrative and investment costs.