About the authors: For over 25 years, Cynthia S. Meyers, CFP®, MBA, has assisted people with their Lifetime Financial Planning–helping to build and preserve wealth in every area of life. Jenny Hood, CFP® has been a paraplanner with Cynthia S. Meyers for five years and enjoys being a part of the financial planning process. They offer their expertise for families working to save for college:
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Life moves fast sometimes. Remember when your child was an infant? It’s hard to believe how many years have passed and how many milestones have been reached. Whether your child is an infant, toddler, or teenager, in the back of your mind, you are always wondering what challenge your child will face next. College may be one of those challenges. Your challenge will be how and where to save for college.
Here are some of your options:
For higher education funding, a 529 college savings plan may be most beneficial. This vehicle allows you to invest money for college without paying taxes on the distributions. Each 529 plan is affiliated with one of the states. However, you do not need to be a resident of the state whose 529 plan you choose, nor does your child need to attend a college in that state. You could live in California, invest in Virginia’s 529 plan, and your child go to college in Washington. Look for a state plan that has low expense fees and a balanced variety of investment options. The 529 account has an owner, who then designates a beneficiary. The owner is in control of the account and can change the beneficiary at any time. Since the owner of the 529 is typically you, the account has a low impact on the Free Application for Federal Student Aid (FAFSA), if your child will require student loans. [CMC editor’s note: FAFSA’s calculations are used by colleges to determine a family’s “need-based aid”, which may include student loans AND grants.] Contributions can come from anyone—you, the grandparents or other relatives, or friends. If money remains unused in the 529 after your child finishes school, you, as owner, can change the beneficiary to anyone in the beneficiary’s family, including yourselves, or close the account and take back the money. However, the earnings portion of the account only will be subject to a 10% penalty plus income tax.
While a 529 restricts use of the funds to higher education expenses, a CUTMA (California Uniform Transfer to Minor Account) allows funds to be used for other purposes that benefit the child as well. A CUTMA allows you to register the account in your child’s name with you as custodian. As custodian, you can direct the use of the funds for your child’s benefit exclusively. All federal and state taxes will be based on your child’s tax rate as long as the earnings do not exceed $1,900 per year before your child reaches the age of eighteen, or up to 24 for full-time students. If earnings exceed this amount, the excess will be taxed at your income tax rate. Even though a CUTMA has tax advantages, you may wish to consider not using a CUTMA since it is considered the child’s asset on the FASFA and since the child will gain control of the assets at the age specified in the title (the default age is 18 in California, but can be up to age 21, if specified on the application).
Another alternative is to open an investment in your name (such as a Roth IRA or a non-retirement account) and earmark the account for the benefit of your child and designate as such in your will. Since this account is in the parent’s name, it would also have a low impact on the FAFSA. This option would allow for the most flexible use of funds, but may not receive any tax benefits, may add to your income taxes each year, and could create a large capital gains tax when the account is liquidated to pay for college expenses.
Stay tuned! In our next blog we tackle the issue of comparing the different state’s 529 plans and how to choose the right one to fit your needs.
