State College, PA - Centre County - Central Pennsylvania - Home of Penn State University

Investing in Your Child’s Future

by on May 14, 2017 5:00 AM

By Brittany N. Cox, Financial Advisor with Nestlerode & Loy Investment Advisors in State College

It’s no surprise that college tuition rates are increasing. Tuition hikes have outpaced inflation by a large margin. The average college graduate in 2016 has more than $37,000 in student loan debt. This amount is about 6 percent higher than it was in 2015. The average monthly student loan payment for a borrower between ages 20 and 30 is $350.

The burden to pay for college education often falls on parents or guardians. In my own situation, I had the advantage of receiving a staff discount on my tuition but I still did not completely escape the burden of student loans.

The key to being prepared for these expenses, like any other financial goal, is early planning.

Start as soon as the baby arrives. The earlier you start to save, the longer your money has to grow. You can start saving for your child’s college education with as little as $50 a quarter. That is less than 56 cents per day.

There are many options available to invest for your child’s future, but the only plan that offers both tax deductions and tax-free withdrawals when used for college is the 529 plan. A 529 plan is a savings plan designed to set funds aside for future college costs. In 1996, Section 529 of the Internal Revenue Code created these savings plans. 529 plans can be used to meet the costs of qualified colleges nationwide. You may choose from two types of 529 plans: a savings plan which works like an IRA account by investing contributions in mutual funds and similar investments, or a prepaid plan which lets you pre-pay all or part of the costs of an in-state public college education.

In Pennsylvania, contributions to a 529 plan are tax-deductible for state income tax. The earnings in the account grow federal income tax free. There is no tax on the withdrawal as long as the funds are used to pay for qualified college expenses such as tuition, supplies, fees and books. If the funds are not used for educational purposes, there will be a 10 percent penalty imposed on the withdrawal. The owner of the account is generally the person who makes the contributions and the beneficiary is the person intended to use the funds for college. The beneficiary of the account can be changed if necessary. The owner maintains control of the account.

Another type of college savings vehicle is a Coverdell Education Savings Account (ESA). Eligibility to invest in a Coverdell is based on your modified adjusted gross income (MAGI). The funds in a Coverdell are used to finance qualified education expenses for the designated beneficiary. A child can be the beneficiary of multiple Coverdell ESA plans. However, there is currently an annual $2,000 limit on the contributions that can be made for the beneficiary.

Contributions to a Coverdell are not tax deductible, but contributions do grow tax free until withdrawn. Also, distributions are tax free if they are not more than the beneficiary’s adjusted qualified education expenses for the year. Once the beneficiary turns 18, no more contributions can be made to a Coverdell account. Coverdell ESAs can be rolled over to another Coverdell ESA for the benefit of a member of the beneficiary’s family who is under age 30 and the beneficiary can be changed on the account.  Once the beneficiary finishes their higher education, the funds can be distributed when the beneficiary turns age 30.

One other savings vehicle worth mentioning is a Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA) account. The purpose of these accounts is to gift money to a minor. These accounts require a custodian who is an adult, typically a parent, who controls the investments and any distributions before age 21. There is no income limitation to open an UGMA or UTMA account. Transferring assets to a minor may lower income taxes for the donor. The taxes on the first $1,050 of unearned income for the minor is exempt, the second $1,050 is taxed at the child’s tax rate and more than $2,100 is taxed at the higher of the child or parents’ tax rate. When the child reaches age 18-21(depending on the age of majority in your state), they gain control of the assets and may use them as they see fit.

Note, however, that UGMA and UTMA accounts may affect the amount of financial aid the child receives.

There are many benefits and disadvantages to each type of account and I could not go into full detail in this one column. Please give me a call to review your individual situation to find a solution that works best for you to invest in your child’s future.

Brittany Cox is a Registered Investment Advisor who works for Nestlerode & Loy, Inc., State College. She serves clients in Centre County and all of Pennsylvania as a fiduciary, fee-based advisor. She is a graduate of the Pennsylvania State University with a BA in business with a focus on financial services. Brittany enjoys working with clients for retirement and college planning. Brittany can be reached at [email protected]
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