How to Properly Fund Your Children’s Education

Geneen Vonkloha

Written by Geneen Von Kloha

I have three little girls to fund college education for. Their births were strategically 3½ years apart, perhaps a valiant effort at spreading the burden of college education funding.

When I graduated from Mizzou, the average annual in-state tuition cost was $4,439. Today, that figure is $10,586. Out-of-state students pay a whopping $14,612 tuition premium, or $25,198 for that same education. That’s just slightly below the $25,514 estimated ‘all-in’ cost of attendance this year for an in-state student.

In the past five years, the published in-state tuition and fees amounted to an average annual price increase of 4.6%. Nationally, university tuition prices are rising around 5% per year. Based on these figures, it appears the estimated annual cost of Mizzou for our oldest daughter (Gylian, age 8) will be approximately $17,243 in 2025, for our middle child (Georgiana, age 4) $20,960 in 2029, and for our toddler (Genevieve, age 16 mos.) $24,263 in 2032. Assuming a typical four year degree, that’s an estimated total financial commitment of $269,238 for tuition only for three children. Add in room/board, books/supplies, and transportation/personal expenses, and the estimated figure jumps to $648,907.

Governor Jay Nixon announced on Monday, September 21st he is freezing tuition for Missouri undergraduates for the 2016-2017 school year. He also announced Missouri ranks first in the nation for holding down tuition increases at public universities.

However, I don’t anticipate any of our children will follow in my footsteps (they are already exhibiting their own independent agendas). On average, tuition and fees for private universities cost $32,599 for this school year, according to data reported to U.S. News by 711 ranked private schools. The ten priciest schools charge an average of $50,632 (before room/board, textbooks and other expenses). If we need to set aside funds for Vassar College for three children, tuition is “only” estimated to be $1,285,657!

How do we properly prepare for funding our children’s education?

There may be scholarships or grants that can aid the burden, but unknown in advance. Educational loans (by student or parent) and work-study programs may also present themselves. However, eligibility is usually based on financial need, thus making it unavailable to many middle and upper income families.

Tuition can be paid directly by relatives, friends and others and is exempt of the annual gift tax exclusion. Again, not a guarantee, and room/board, books/supplies, and transportation/personal expenses are not exempt of the annual gift tax exclusion.

Systematically saving now, just like we are doing for our retirement years given the time value of money, makes the most sense to us. There are many strategic alternatives to saving for college education funding, including the following:

529 Savings Account Plans allow your savings to grow tax-free and the earnings are completely tax-exempt at the federal level if the withdrawals are used for qualified college expenses, including tuition, fees, room/board and books/supplies. Two-thirds of states give residents a tax deduction for contributions, including Missouri (MO$T – $16,000 if Married Filing Jointly) and Illinois (Bright Start – $20,000 if Married Filing Jointly). The plans set no income limit, but contribution limits vary from state to state and are generally hundreds of thousands of dollars to avoid additional tax consequences. In Missouri, you can contribute up to $325,000 for the same beneficiary. In Illinois, it is $350,000. If a contributor does not wish to file a gift tax return, however, annual contributions should stay at or below the annual gift tax exclusion (presently $14,000 per person).

Both MO$T and Bright Start allow combined five-year gifts (termed superfunding) of up to $70,000 for single filers or $140,000 for married couples filing jointly per beneficiary. It has to be accounted for over five years on taxes, and in the event of a premature death, a portion of the election amount comes back into the donor’s estate. However, any earnings in the 529 account remain outside of the donor’s estate. Concerned your child may decide to go to a vocational school? So long as the school is accredited and eligible to receive federal student aid, then it is considered a qualified institution.

Custodial accounts, known as UTMAs (for the Uniform Transfers to Minors Act) and UGMAs (for the Uniform Gifts to Minors Act), allow you to save money or other assets for a minor child and manage the account as custodian until the child reaches 18 or 21, depending on your state (age 21 for both Missouri and Illinois). Once you have transferred assets into a UTMA or UGMA, you are not permitted to take those funds back (they are an irrevocable gift).  Important to note: custodial accounts are not trust funds. In fact, the whole point is to permit you to transfer property to a minor without establishing a trust. The legal framework for trusts such as a 2503(c) is much more elaborate, and costly, than for custodial accounts.

There is no cap on contributions to a UTMA or UGMA, but keep in mind the annual gift tax exclusion. From a tax perspective, the first $950 of unearned income is tax-exempt. The second $950 of unearned income is taxed at the child’s rate, and any earnings above $1,900 are taxed at the parents’ marginal rate. Investment choices in UTMAs or UGMAs are not as restrictive as 529 accounts (although, MO$T offers a very good platform of Vanguard funds, and Bright Start offers both Vanguard and Oppenheimer strategies).  On the downside, large balances in UTMAs or UGMAs can hurt chances for financial aid.  UTMAs or UGMAs count as student assets, and the federal financial-aid formula calls for students to contribute 20% of savings versus 5.6% of savings for parents where 529 accounts are considered parental assets.  529 accounts owned by grandparents have no impact on financial aid (because the account owner has the authority to change the beneficiary at any time).

Furthermore, the assets in UTMAs or UGMAs are not specifically designated for college education. They may be used for any number of things, including, but not limited to, house down payments, weddings and new vehicle purchases. The downside is that these assets become the child’s to spend as they see fit at the age specified by the applicable state. Some parents are not exactly thrilled with the idea of children inheriting money at such a young age.

Coverdell education savings accounts are similar to 529s, but expand the definition of ‘qualified’ to include tuition at private elementary schools and high schools. However, the total amount you can contribute per child cannot exceed $2,000 a year. The contributor’s modified adjusted gross income must be less than $110,000 for single filers and $220,000 as a married couple filing jointly.

A Roth IRA can be used to both help fund your retirement and your child’s college education (assuming you have held the account for at least five years). The money contributed to a Roth grows tax-free. In general, you can only make tax-free withdrawals on your contributions. However, if you use the money for educational expenses, you can avoid the 10% early-withdrawal penalty on earnings that are otherwise applicable to withdrawals made prior to age 59½. In 2015, the ability to contribute $5,500 to a Roth IRA ($6,500 if age 50 and over) disappears at a modified adjusted gross income of $131,000 for single filers and $193,000 for married couples filing jointly.

Your Moneta Group Family CFO is a wealth of knowledge on the vast array of potential options available to you to help save for your children’s college education.  Utilize the resources you have at hand to help you save for something so important down the road.

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