By Tom Taulli, Barron’s featuring Vincent R. Birardi, CFP®, AIF®, Wealth Advisor at Halbert Hargrove
An important role for a financial advisor is helping clients save for their children’s college costs, including setting up 529 plans. These plans have clear tax and estate planning advantages.
College costs are likely to continue to rise. The College Board estimates that the tuition and fees for a four-year private college education at $38,080. Assuming 5% inflation, this means the cost will be $87,280 in 18 years. College Board averages don’t include room and board. Some top schools, including Ivy leagues, cost around $70,000 a year all in.
“Investors may be putting goals like saving for retirement and generating investment income at risk” when they do not consider the potential for sky high college costs to get in the way of their plans, says Rachel Ramos, senior product manager of CollegeAmerica at Capital Group.
“At the same time, a majority of advisors think saving for education is very important,” she says. “There’s an urgent opportunity for advisors to address that gap, especially given that many say their clients underestimate the cost of saving for an education.”
About 40% of financial advisors in a recent Capital Group survey say intergenerational wealth management and serving the next generation of clients is their main focus for growing their practice. This is the second most popular strategy, just behind an emphasis on new client acquisition and referrals, which 71% of the respondents said was the main way they are trying to grow their practice.
Here are some key facts about college saving plans:
Types. There are two kinds of plans available. A prepaid tuition plan allows a client to lock in today’s costs through the use of credits. This is only available at a limited number of colleges and a client cannot use the credits for room and board.
Next, there is the 529 college savings plan, which is the most common. This is an account that usually is invested with age-based funds. The asset allocation gradually changes from aggressive to conservative investments as the student nears college age.
Taxes. A 529 plan provides for tax-free growth. If the money is used for qualified educational expenses, there are no taxes on the distributions. This goes well beyond tuition and fees. You can use a 529 plan for a computer, supplies, books, dorm fees, and off-campus housing. You can also use the money for K-12 tuition (up to $10,000 a year), community colleges, trade and technical schools, graduate programs, and even certain apprenticeships.
Many states provide additional tax advantages. “Over 30 states and the District of Columbia currently offer a state income tax deduction or tax credit for 529 plan contributions as well,” said Vincent Birardi, a CFP and wealth advisor at Halbert Hargrove.
Control. A 529 plan is not like a Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account, which allows the beneficiary to access the funds when they reach the age of 18 or 21. Instead, the owner of the account has full control. They can decide when to release any funds or change the beneficiary. This does not have an impact on the taxes.
Estate planning. High-net worth clients can superfund their 529 contributions. “This is a 5-year gift-tax averaging strategy that allows families to front-load their contributions without having to pay gift taxes, while protecting their lifetime gift and estate tax exemption,” said Jonathan I. Shenkman, president and financial advisor at Shenkman Wealth Management.
“The annual gift tax exclusion amount is $16,000 per donor per beneficiary in 2022. A family can give five times that amount as an upfront contribution of $80,000 or $160,000 for couples, per beneficiary. This is a wonderful way to get assets out of one’s estate and make sure the funds are earmarked for something important, like college or graduate school.”
This is not only for parents. It’s common for grandparents and great grandparents to fund 529 plans.
“Grandparents love the idea of leaving an educational legacy as they know it will be of value to their grandchildren and a helping hand to their adult children who may be struggling to save for the very same goal,” said Patricia Roberts, chief operating officer at Gift of College, Inc., and author of Route 529. “As such, an advisor has an opportunity to get acquainted with a grandparent, an adult child, and grandchildren when they grow up all through the development of an education savings strategy with a 529 plan.”
