David K. Little, CFP®, CFA

Good news: Your brilliant child has been accepted to one of the most highly rated private colleges in California. Bad news: You’re going to have to figure out how to pay for it. Just to make sure you’re sufficiently afraid of this scenario, here are the estimated costs for Chapman University, one of Orange County’s most prestigious providers of a college education. As fee-only financial advisors in Fullerton, we frequently get questions about paying expenses at these levels.

Tuition                             $50,200
Fees                                 $400
Room and board              $14,900
Books/supplies                $1,600
On-campus misc.             $2,400
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Total                                 $69,500

For almost all families, even in relatively wealthy Orange County, this kind of expense will put a serious dent in the budget. So, what’s the best way to prepare to pay these education expenses? Is it a federal student loan, credit cards, an equity line of credit, other federal loans, a college savings plan, a 529 plan, or something else?

Let me take you back to when your high school senior was a wide-eyed newborn and you were too busy enjoying her to think about the college costs that you’d eventually have to figure out how to cover.

Back in 2001, when she was born, college was much cheaper, but even then, costs were increasing at a rapid clip. Most years, the cost went up by at least 4% a year, and some years reached 7–8%. Over the 18 years she’s been alive, costs have gone up by an average of about 5% per year.

If you had sought out the services of a financial advisor 18 years ago, that advisor (ideally a CFP® professional) probably would have told you that putting money into a 529 plan would have been the best option to pay for college. At Eclectic Associates, we would have agreed with that advice.

Here's a quick refresher on 529 provisions and why, as Fullerton financial advisors, we like them so much.

• Although deposits into 529 accounts are not tax-deductible, the money in the accounts grows tax-free over the years. And as long as the money is used to pay for college expenses of the beneficiary, there is no tax on the growth.

• You, as the account owner, control the ultimate disposition of the money. If that beautiful, wide-eyed daughter of yours decides when she’s 18 that she’d rather join the rodeo and not go to college, you don’t have to give her the money. This is in contrast to the old UGMA/UTMA accounts, where legally the money became the property of the children when they reached a certain age (usually 18 or 21).

• If college doesn’t happen for your beneficiary, you can transfer the money to a relative and allow them to use it for school. “Worst case,” you can take the money back for yourself. In that case, assuming it’s not used for college, you’d pay taxes on the earnings, as well as a 10% penalty (only on the earnings).

• Annual deposits into 529 accounts are essentially unlimited, and the lifetime limit is also so high as to be almost irrelevant.

• Withdrawals from 529s can be used to pay for a variety of expenses, including tuition, room, board, fees, books, and essential college supplies.

Here’s advice we’ve given clients over the years on funding 529s and taking withdrawals from them:

• Set up the accounts as early as possible. You have to have a Social Security number for a beneficiary to open an account, but for those extremely forward-thinking savers, you can open an account for yourself before your children are even born and then transfer ownership to them as they come along.
  Why set up the accounts so early, you might ask? Here’s some math:
  At a total cost of $70,000 per year today, Chapman is likely to cost about $168,000/year in 18 years (5%/year increases). To fully cover that cost, you’d need to start saving about $1,200/month the day your daughter is born. Waiting until she’s 3 before you start saving bumps up the monthly amount needed to about $1,700.

• Break what seems like (and is) a huge future expense into smaller, more manageable bites. Monthly savings is a very good way to do this. We typically tell our clients to have their bank accounts debited by the 529 fund company every month. Before long, these monthly transfers become part of their monthly budgets and the money is not missed.

• If possible, have the 529 plan send college costs directly to the school so there’s no question about whether the expenses are qualified. We’ve been through an IRS audit of whether expenses paid for with 529 plan money are qualified, and as soon as we told the IRS that the money went to the school without touching our client’s hands, they stopped asking questions. It is possible to pay expenses and then seek reimbursement from the 529, but in that case, you’ll need to be much more careful about saving receipts to justify expenses.

There are certainly other ways to pay for college, but planning ahead and setting money aside as soon as possible usually makes the most sense. We are asked about student loans frequently, but we advise trying to avoid them if possible. Student loan debt totals more than $1.5 trillion at this point, and the average graduate with loans carries a balance of nearly $40,000. Over the life of the loan on a typical repayment schedule, that borrower will pay more than $15,000 in interest.

If you have more questions about saving for college, look for a financial planner near you and schedule an appointment to discuss it with them. We think you’ll be more likely to get good advice if you seek out a fee-only, CERTIFIED FINANCIAL PLANNER™ professional.

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