Paying for Increasing Education Costs
Tuesday, April 4th, 2017
As costs for higher education continues to rise, many families are becoming concerned about which is the best strategy to pay for college. Due to the rising costs, there is a good chance that even with scholarships and grants, there will be a shortfall.
One popular vehicle has been a 529 plan because it offers tax-deferred growth and tax-free withdrawals if used for qualified education expenses. However, 529 plans are run by the state or an educational institution, so investment options are limited to the funds offered by the sponsor, all of which have fees. In an attempt to save on taxes, many parents experience poor performance with little growth from the available funds. Also, if a 529 is used for something other than education, earnings will be taxed as ordinary income and incur a 10% penalty on the withdrawn earnings. To avoid the penalty, the beneficiary would have to be changed to a family member who uses the account for education purposes. This may result in supporting a family member who they had no intention to help, while unable to help their own children without paying a penalty. If no other family members attend college, the parents could be stuck paying penalties to use their own money. These plans seem attractive, but many parents become frustrated with their functionality and cannot escape the restrictions.
Some parents have decided to use funds from retirement accounts to help students pay for college. When accessing a 401(k) for education purposes, there will be a 10% penalty if the owner is younger than 59½, so this option should never be used. When using an IRA, the owner will still have to pay ordinary income tax on the withdrawal, but there will not be a penalty. However, using retirement accounts for college can lead to various problems when retirement is supposed to begin. A retirement nest egg can be devastated by college costs which results in a much lower standard of living or delayed retirement. College can be financed, retirement cannot, so it is not wise to deplete retirement savings especially when there are other options available.
Many students have turned to loans to pay for college. For many, this provides an opportunity that would otherwise have been impossible. Since interest rates on loans are generally lower than market investment returns, loans should not be ruled out as an option. If loans are taken, the student must have a plan to graduate in a reasonable amount of time with a degree that will lead to a career. The expected future income from the chosen degree should reflect the amount of loans taken to receive it. In other words, it is not wise to accumulate massive amounts of loans for a degree with no income potential.
Another option is to use savings from ordinary investment accounts. This method will incur no penalties and keep control in the hands of the owner. This allows parents to set aside money to be invested in any way they choose while their children are young. When it comes time for children to attend college, the money will be available. If the children decide not to go to college, the money can be used to assist them start a business, buy a house, fund the parents’ retirement or anything else they desire. With this option, the parents can use their hard-earned money in any way they choose when the time comes. Focusing on building your net worth provides the necessary flexibility when it comes to education planning and other financial hurdles you may face over the course of your life.
Every family’s condition is unique, so there is no one-size-fits-all strategy for education planning. To find out how to make smarter decisions based on your situation, contact Wilsey Asset Management.
Do you have a question or a company you'd like us to take a look at? Email us at Brent@WilseyAssetManagement.com or Chase@WilseyAssetManagement.com.