Finding the right college savings plan

 Bernadette Starzee, The Daily Record Newswire

Planning for a child’s college tuition starts with taking an inventory.

“It’s like anything else,” said Charles Massimo, president and founder of CJM Wealth Management. “You look at your resources, how many years you have to save, how much college will cost, how much of the education you want to pay for and the opportunity for financial aid.”

Once they make their assessment, many parents turn to a 529 college savings plan, a state-sponsored, tax-advantaged product established in 1996. By the end of last year, there were 11.6 million 529 accounts totaling $227 billion, for an average of $19,584 per account, according to the College Savings Plans Network.

A 529 can be used to pay for college tuition, fees, room and board and other qualified expenses at an accredited school. The parents’ names go on the account and an individual child is listed as the beneficiary.

There are many advantages to a 529.

“Money you put into it grows tax-deferred, and when you use it to pay for qualified expenses, it comes out tax-free,” Massimo said.

Further, the plans are flexible.

“Let’s say your son or daughter gets a scholarship and doesn’t need the money, and another son or daughter is ready to go,” Massimo said. “You can easily change the beneficiary.”

Third parties can make contributions to a child’s 529, which means Grandma can gift money to the child’s account for birthdays and holidays, said Christopher Zarra, a private wealth adviser with Zarra & Associates.

But buyer beware: not all 529s are created equally. Adviser-driven 529s, which are offered through financial advisers, have higher fees because they include investment advice. There are also do-it-yourself 529s with significantly lower fees.

“There’s a reason why the adviser-driven 529 is popular,” Zarra said. “With the do-it-yourself 529, you get no investment advice.”

Massimo is not a fan of the adviser-driven plans, however. His firm recently compared a plan that a client came in with from one of the large brokerage houses to a do-it-yourself plan through Vanguard. The adviser-driven plan had 1.5 percent in fees per year, compared with 0.2 percent in fees for the 529 from Vanguard.

“That’s a huge difference over 20 years,” Massimo said, noting he cautions clients that “as much of their investment as possible should be going to returns, and as little as possible to fees.”

Another limitation of the 529 is that it can’t be used for unqualified expenses. If parents sock away more than needed for education and try to use the funds for another purpose, they’ll be subject to tax on the growth portion, Szczurowski noted, plus penalties.

Some advisers suggest a mix of 529s and Uniform Gift to Minors Act custodial accounts, which are in the child’s name. Prior to the advent of 529s, UGMAs were a more popular college savings vehicle. However, they have fallen off considerably, in part because they don’t offer the tax advantages of the 529.

Another mark against UGMAs is that funds in the child’s name are penalized at a rate of 20 percent or higher when the expected family contribution is calculated to determine financial aid eligibility. By comparison, assets in the parents’ name, including 529s, are hit up at an annual rate of just 5.6 percent.

“The child’s junior year of high school is an important tax year,” Zarra said. “It’s a good time to sit down with your financial adviser and figure out if there’s anything you can do to give you more advantages going into the financial aid process.”

Some parents mistakenly assume they’ll be considered too well-off to qualify for financial aid, said Massimo, who recommends clients have a sit-down with the college’s financial aid officers.

“A lot of families don’t take enough time to learn about financial aid,” he said. “I have seen families of wealth qualify for financial aid — it’s a matter of finding it.”

Colleges are actively recruiting wealthier families because of the greater potential for donations, added Massimo, who also counsels clients not to overlook the option of using cash value life insurance policies to fund college expenses.

“It’s a great resource to tap into; the money comes out of the policy tax-free, and you pay yourself back,” he said. “It’s like you’re creating your own bank.”

No matter which savings vehicles are used, it’s important to start early, so the money has time to grow. Zarra, for instance, opened a 529 account the year of his child’s birth.

But families should keep college savings in perspective.

“We don’t want our clients to have tunnel vision,” Szczurowski said. “If you put all your money into college, it would leave nothing for retirement.”