By Shane Cummings, CFP®, AIF®, Wealth Advisor & Director of Technology/Cybersecurity
Student loan debt has become a major political issue, prompting many students to reconsider their long-term college paths. Still, a college degree can confer long-range benefits in terms of career earnings. According to a College Board study from 2023, the extra income for an average bachelor’s degree holder is $38,930 for just one year.
No one wants to spend more than they need to on education given the price tag, so it’s more important than ever to have an intelligent strategy for yourself or a student in your family.
Establishing the appropriate postsecondary education path
For some students who are more likely to need extra time for core courses or haven’t yet decided on their major, one possible cost-reducing strategy is to utilize community college for the first few years. The average annual cost of tuition and fees for community college is $3,990, offering an opportunity for significant savings. Also, given that undergraduates these days are more likely to need five years to complete their degree, spending a few years in community college before transferring to a four-year university could significantly reduce potential student debt or family costs.
There are some tradeoffs of course – transfer students may miss the opportunity to build relationships and network in their freshman and sophomore years of college. But for families feeling pinched in investing for college, this can be a trade-off worth making.
Also, if a student has chosen a trade and doesn’t need a four-year diploma, some college savings programs such as 529s can also be used for apprenticeship programs and vocational or trade schools. It’s still useful to be familiar with the different types of investment strategies and to make use of potential tax benefits. Parents can begin saving when their student is young, knowing that some of these strategies will be flexible enough if the student’s education or career goals change.
Choosing the appropriate college savings vehicle
Three common college savings vehicles are 529 college savings plans, custodial accounts, and Coverdell Education Savings Accounts. Another option is simply to put cash into a savings account and earmark it for the student.
Each account type has its own features and benefits, but 529 college savings plans typically prove to be the more beneficial and flexible for families to use.
- Coverdell Education Savings Accounts operate like an IRA for educational purposes. One of the bigger drawbacks is that only $2,000 per year per beneficiary can be contributed, limiting the amount that can be saved. Also, Coverdell account funds typically must be used by the beneficiary by age 30, which limits long-term flexibility.
- Savings in a custodial account are taxed each year, and must be moved to the control of the beneficiary at the age of majority (either 18 or 21 depending on state of residence). Funds are not required to be used for education purposes.
- That brings us to 529 accounts. Funds contributed grow tax-free and withdrawals are not taxed if withdrawn for qualified educational expenses. Contribution limits are very broad, allowing up to $180k to be contributed to a beneficiary’s 529 in a single tax year if the donor chooses to accelerate five years’ worth of gifting into one tax year. Since the passage of Secure Act 2.0, 529 plans have an additional feature: Some of the remaining savings can be converted into Roth IRA retirement savings for the beneficiary, up to a maximum of $35k (if eligible). And if the beneficiary does not need the funds or too much is saved, the beneficiary can be changed to someone else in the family.
Optimizing for college student aid
Each academic year, parents are encouraged to fill out the FAFSA (Free Application for Federal Student Aid) to see if their student qualifies for any financial aid. The Student Aid Index (SAI) is subtracted from the total college cost to arrive at the student’s financial aid. The SAI is derived from combining a fraction of the parents’ income and non-retirement assets (including 529 assets) with a fraction of the student’s income and assets. Reducing the SAI number broadly improves your chances of receiving financial aid, although that’s not guaranteed.
529s help minimize the amount of assets counted in the student’s net worth for the student aid calculations. 529 assets are assessed at only up to 5.64% of their value when calculating the SAI. By comparison, any custodial account assets are counted at 20% in student aid calculations, as are any cash savings accounts in the student’s name. Cash savings are generally not an attractive option for this reason – in addition to counting more in student aid calculations, they generally tend to achieve a low rate of return relative to investing in stocks, bonds, and other assets typically available in 529 plans, Coverdell IRAs, or custodial accounts.
For multigenerational families where multiple members are able to save for a student, grandparent–owned 529s are counted at 0% for student aid calculations due to recent FAFSA changes (previously they were included). In other words, if you’re able to get grandparents involved in college savings and integrate them into the funding plan, this could improve the student aid calculations and increase financial aid eligibility.
Recent changes to the FAFSA may help or hurt student aid
Recent changes to the FAFSA may have varied effects on a student’s aid eligibility. Families with multiple college students are now at a disadvantage, as calculation changes mean they are now expected to pay more for each enrolled child. Additionally, business owners or farmers now have to report the net worth of their business or farm in calculations, regardless of size – whereas previously this was only required for businesses with more than 100 employees.
On the positive side, income and asset reporting changes mean that any pre-tax contributions to parent’s company retirement plans or worker’s compensation are not includable. If a parent is making Roth contributions to their workplace retirement plan, they could consider switching contributions to pre-tax plans in the years leading up to their children entering college. That’s because for each school year you apply, SAI is based on income from the previous two years.
The world of college savings and funding has become increasingly complicated over time. Rule changes will likely continue to occur, so a periodic review of your savings plan is critical. Having your HH advisory team on your side can help you navigate these opportunities and chart a path forward.
Disclaimer:
Halbert Hargrove Global Advisors, LLC (“HH”) is an SEC registered investment adviser located in Long Beach, California. Registration does not imply a certain level of skill or training. Additional information about HH, including our registration status, fees, and services can be found at www.halberthargrove.com. This blog is provided for informational purposes only and should not be construed as personalized investment advice. It should not be construed as a solicitation to offer personal securities transactions or provide personalized investment advice. The information provided does not constitute any legal, tax or accounting advice. We recommend that you seek the advice of a qualified attorney and accountant.
