Congratulations! You’re a new parent! You probably have a lot on your mind with all of the immediate challenges and rewards that come with this “job,” and you may not feel prepared to think 18 years into the future. However, it behooves all parents, first-time or otherwise, to start planning for their child’s college education from Day 1, even if it produces a lot of anxiety or seems like something you can put off for a bit.
As a financial adviser for 13 years, and a parent for 22, I have both seen and experienced the distress. I have said to many a client: “Kids — they suck the financial soul right out of us, but it’s all worth it!”
The following are some crucial things to consider when it comes to college funding, which I hope will help ameliorate some anxiety and help prepare you for a conversation with your financial adviser.
Do not wait until next month, because that becomes next year, and so on — until your child is 14 and you realize you simply may not have enough time to build a substantial fund for them. Procrastination is a powerful, insidious human tendency, and you need to commit to beginning this journey immediately.
Setting aside just $15 a month is a great start when you’re in the early days of parenthood. Even if you’re only using a savings account, the key is to automate the process so that you are routinely depositing that $15 every single month. While it may seem small, putting away $15 on a monthly basis into an account with 1.00% interest will yield $3,569.21 in 18 years. Invest in a manner that generates a 5% return, and that number grows to $5,839. Scale up the monthly contribution each year, and the number grows exponentially.
Within the first six months of your child’s life, you should decide what type of dedicated account you will use for college funding over the remainder of his or her formative years. These are your primary options:
- 529 Plans: Accounts that provide tax-free growth when the dollars are used for educational expenses, whether it be college or a private grade school/high school. The contributions go into the account after tax, but earnings accrue tax-free. Your individual state may also provide a tax break through a sponsored plan. It’s a compelling and effective way to save. However, 529s do not come without caveats. If the child chooses not to go to school, the account can be changed to another family member and used properly. If the account is used for non-educational expenses, the earnings are taxed and you could be susceptible to an IRS and state penalty, as well.
- Custodial Accounts: A brokerage account opened by a parent (or grandparent) in which money is invested to provide long-term growth for the period until college. These accounts provide greater flexibility than 529 plans and can be used for any expense to benefit the child. The parent is simply funding the account, making decisions on how it is invested, and then taking out proceeds as needed to support their child – everything from college to new shoes to a car. Keep in mind, though, that when the child reaches the age of majority (depending on the state, age 18 to 21), he or she then technically “owns” the account and can do whatever they want with it. There are some tax advantages with a custodial account, but not nearly as favorable as with a 529 plan. For example, the first $1,050 of earnings in a custodial account are tax free, and the next $1,050 is taxed at the child’s tax rate (usually $0). Earnings beyond that $2,100 per year, however, are taxed at the parent’s tax rate, so amassing significant assets in a custodial account can lead to tax pain for the custodian.
- Roth IRAs: Some parents hedge their bets. What if Junior decides not to go to college? What if he decides to surf in Oahu after high school instead? A Roth IRA funded over the formative years can be tapped to assist with college, but if that doesn’t happen, it is there for the parents’ retirement. Contributions to the Roth can be taken out tax- and penalty-free at any time for any reason. Any earnings that are used for college expenses can avoid IRS penalty as well, but they would be taxed as income. Earnings can come out tax-free once the Roth owner (the parent) is over 59½.
Now that you’ve started saving and have picked the account pony you are going to ride for the next 18 years, you must commit to the following:
- Decide what your goal is. Do you want to fund 100% of a public college? Fifty percent of a private school? There are a multitude of calculators you can tap to tell you how much you need to save to accomplish your objective.
- If you can’t immediately fund enough to get to your objective, save what you can and increase the amount each year. If you start at $15 per month and you increase it every year, the compound effect will add up.
- Approach your savings with discipline and rigor. College is expensive (and is getting more expensive), and you may not be able to pay the entire bill, but having something is better than nothing. As with all major financial decisions, there will be healthy friction among college funding, retirement funding, home and car purchases, etc. There is a never-ending prioritization challenge, but it is possible to meet your goals if you dedicate meaningful energy to the process.
Make no mistake, saving for college can be challenging and stressful. Not only are you focused on making sure you set your child up for success, you also have to navigate myriad IRS rules and regulations governing whichever vehicle you ultimately use. That’s why it’s critical that you do your homework — preferably before your child is even born — and consult a financial and/or tax adviser to determine the right way forward for your family.
The opinions expressed are those of the author and do not necessarily represent the opinions of CUNA Brokerage Services Inc. or its management. This article is provided for educational purposes only and should not be relied upon as investment advice.
*Note: Representative is neither a tax adviser nor attorney. For information regarding your specific tax situation, please consult a tax professional. For legal questions, please consult your attorney.
CUNA Mutual Group is the marketing name for CUNA Mutual Holding Company, a mutual insurance holding company, its subsidiaries and affiliates.
FR-2432088.1-0219-0321 ©2019 CUNA Mutual Group
Jamie Letcher is a Financial Adviser with LPL Financial, located at Summit Credit Union (opens in new tab) in Madison, Wis. Summit Credit Union is a $5 billion CU serving 176,000 members. Letcher helps members work toward achieving their financial goals and through a process that begins with a “get-to-know-you” meeting and ends with a collaborative plan, complete with action steps. He is a member of FINRA/SIPC, a registered broker-dealer and investment adviser.