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Cradles Today, College Tomorrow

The cost of college education can be intimidating for new parents. But parents of newborns and young children may have time on their side.

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.

Client Conversations gives financial advisors an easy way to communicate with clients on topics influencing financial markets; it highlights common investor behaviors and offers ways to address the challenges investors face. Share this article with your clients, and remember to follow your firm's policies that govern sharing content with clients and prospects.



Newborns—the joys are limitless. Tiny fingers. Toothless smiles. The intoxicating new baby smell. But first-time and veteran parents alike know that limitless anxieties come along with having a new baby, too. One particular worry that looms large for today’s parents is the cost of college.

Tuition, room, and board today can cost anywhere from $20,000 to upwards of $60,000 at a four-year institution.1 Who knows what it will be 18 years from now? And with student debt in America totaling upwards of $1.6 trillion,2 how could new parents not be nervous?

The best way to save for your child’s college education? Start early.

 

Invest Early, Invest Often

Parents of newborns and young children have one huge advantage when it comes to contributing to a 529 plan: time. This is the most valuable asset out there when it comes to long-term investments. By investing in your child’s education when he or she is still young, you have a large window of opportunity to capitalize on the “magic” of compound interest. Even investing a modest sum may set your child up for success (after all, you have bibs and pacifiers and diapers—so many diapers!—to buy).

For example, if you invest $200 per month from the time your child is born until the day she turns 18, you will have accumulated nearly $78,000, assuming a 6% rate of return. Comparatively, if you begin investing $400 monthly beginning when your child is 10 years old, you will have amassed about $49,000. Investment returns are not guaranteed, and you could lose money by investing in a 529 Plan.

 

FIGURE 1:

Less Can Be More if You Start Early On

This hypothetical illustration is not intended to reflect the performance of any particular 529 plan or its investment options, whose actual rates of return will fluctuate.

 

The earlier you start, the better off you’ll be. Although you may feel it’s difficult to contribute much right now, setting up a plan, putting in whatever you can, and doing so consistently is what matters. Consider setting up automatic recurring contributions online.3 It’s always possible to contribute more later, but in order to take advantage of compound interest, investing now is more important than investing big.

For every birthday from one to 18, family members will be texting you to ask what your child would like as a gift. Sure, you could tell your sister that your son loves Sesame Street. You could tell your mother-in-law that your daughter can’t get enough of Legos. Or, you could ask your family to make contributions to the 529 plan you have set up for your child.

If you have a particularly generous relative (or if you come into an unexpected windfall), there’s a tax provision for 529 plans that allows for five years of allowable contributions to be made simultaneously, exempt of gift tax.4  

What Is a 529 Plan?

  • A 529 plan is a state-sponsored, tax-advantaged savings account that grows tax free.

  • The account owner retains control over the account, even after the beneficiary reaches 18. Beneficiaries can be changed or transferred easily.

  • Effective December 20, 2019, as part of the SECURE Act, qualified withdrawals were expanded to include expenses for apprenticeship programs and repayment of qualified student loans for a maximum lifetime limit of up to $10,000.*

  • Fees and expenses vary by state, as do tax advantages.

  • Returns are not guaranteed, and you could lose money by investing in a 529 plan.

* Qualified-expense status varies by state for withdrawals used for apprenticeship programs and student loan repayment. Non-qualified withdrawals are taxable as ordinary income to the extent of earnings and may also be subject to a 10% federal income tax penalty.

 

Make It a Family Affair

As a grandparent, perhaps you’re considering opening up a 529 to benefit your child. More than one 529 plan may be opened for your child’s benefit, but do your due diligence. A 529 plan opened by a grandparent or relative does not count toward the student’s Free Application for Federal Student Aid (FAFSA). This means that distributions from these 529s will count as income for the student, impacting aid eligibility, possibly significantly.

As a parent, you should know that student income is assessed at 50% on the FAFSA. What does that mean for your child? If $3,000 is withdrawn from this relative-owned 529, the beneficiary’s aid eligibility will decrease by $1,500 for the following year. There are two options in this case. Either the grandparents can transfer ownership to you before your child reaches college age, or your child can cash in on these 529s later in their college careers, once all their FAFSAs have been filed.5

 

FIGURE 2

Average Cost of College

Including tuition, fees, room, and board

Source: College Board, 2019

 

Source: College Board, Trends in College Pricing, 2019

 

But, What If Baby Is a Genius? A Star Athlete? The Next Iron Chef?

If your child receives a healthy scholarship, don’t worry! According to the IRS, the beneficiary can still withdraw money equal to the amount of the scholarship from the account without penalty (though earnings will be subject to income tax). Or, the assets can be put toward graduate school and advanced degrees in the future.

Also, there’s no need to worry that you’re predestining your child to academia by setting up a 529 plan. Qualified education expenses include not only tuition, fees, and supplies at four-year colleges and universities, but also tuition and associated expenses of two-year colleges, vocational and technical schools, culinary school, and even some foreign universities. 529 plans have been expanded in recent years to include tuition fees for K-12 private schools, and fees associated with apprenticeship programs.

 

Use It or Lose It?

There are other options for any money that may linger in a 529 after a child’s graduation.

Thanks to the SECURE Act, 529 earnings are now applicable for student loan repayments. Account holders have the option of using up to $10,000 to pay off qualified student loans. This $10,000 repayment option is a lifetime limit for the beneficiary and each of the beneficiary’s siblings to use toward qualifying student loans.

Funds also may be rolled over, without tax consequences, to relatives of the beneficiary that include but are not limited to: siblings, children, in-laws, spouses, and first cousins. The IRS says you can even make yourself the beneficiary. 529 plans never “expire” either. There’s no limit on the number of times the beneficiary can be changed over the lifetime of the account. If there’s no one in your family you would like to transfer the account to after your child’s graduation, you can transfer ownership of the account to your child so they can use it for their own children or grandchildren one day.

529 plans are advantageous to anyone seeking to pay for education, whether it be for yourself, child, or grandchild. However, their potential is greatest when they are established early in the beneficiary’s life so there’s ample time for the power of compounding to potentially grow the investment.

Source: IRS, 2019

* If using a 529 plan for K-12, it can only be used for tuition up to $10,000 per year.

**Can be used for student loan repayment for a maximum lifetime limit of up to $10,000

Talk to your financial advisor to make
the most of your 529 plan. 





1 Collegeboard.org, 2019

2 CNN, “The student loan debt is $1.6 trillion and people are struggling to pay it down,” 1/19/20

3 Continuous or periodic investment plans neither ensure a profit nor protect against a loss in declining markets. Because these programs involve continuous investing regardless of fluctuating price levels, you should carefully consider your financial ability to continue investing through periods of fluctuating market prices.

4 If the donor elects to treat a gift as being made over five years, and the donor dies prior to the end of that five-year period, the portion of the gift allocable to the period after the donor’s death will be included in the donor’s estate. Estate-tax treatment may differ by state. Any additional gifts to the same Designated Beneficiary in that five-year period would be subject to federal gift tax. Please consult your tax advisor for more information.

5 SavingForCollege.com, “How to Make Sure Your Grandchild’s 529 Plan is Used for College,” 8/12/2019

 

Before investing, an investor should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s 529 plan.

For more information about any 529 college savings plan, contact the plan provider to obtain a Program Description, which includes investment objectives, risks, charges, expenses, and other information; read and consider it carefully before investing. Hartford Funds Distributors, LLC serves as distributor and underwriter for some 529 plans.

All information provided is for informational and educational purposes only and is not intended to provide investment, tax, accounting or legal advice. As with all matters of an investment, tax, or legal nature, you and your clients should consult with a qualified tax or legal professional regarding your or your client’s specific legal or tax situation, as applicable. The preceding is not intended to be a recommendation or advice.

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